California Non-Competes Must be Carefully Connected to Sale of a Business

January 12, 2013 (Press-News.org) If you are a California employer, how can you stop an employee from taking his or her skills or knowledge to a competitor? In general, you can't because California law prohibits non-compete agreements in most cases. However, an interesting recent case involving two non-compete agreements addressed an exception to the rule.

California law generally prohibits non-compete agreements in the employment context, because the law wants to promote a policy that favors employee mobility and the right to pursue a livelihood. However, California law makes an exception to this rule by allowing non-compete agreements when they are connected to the buying and selling of a business.

The reasoning behind this law is that the buyer of the business has an interest in prohibiting the seller from destroying the value of the business by competing against the business that he or she just sold. Because of this, California law generally upholds any reasonable restriction on competition when such an agreement is based on the sale of a business.

Background of the case

In the case entitled Fillpoint v. Maas, Michael Maas was a key employee and shareholder of a video game publisher, which was being acquired by another company. As part of the acquisition, Maas sold his stock to the company and signed a stock purchase agreement that contained a non-compete agreement that prohibited him from competing for a three-year period following the acquisition. In addition, Maas also signed a separate employment agreement that had a non-compete provision that prohibited him from competing against the company for a one-year period after his termination of employment.

Maas continued to work for the company for three years, but decided to resign to work for a competitor, which violated the one-year restriction in his employment agreement. The company sued Maas for the violation of the employment agreement. The issue to be decided was whether the employment agreement's one-year non-compete clause was sufficiently tied to the sale of the business, which would make it, fall under the law's "sale of business" exception to its general prohibition of non-compete agreements.

Decision

The court held that the two non-compete agreements had to be read together in order to decide whether the provisions were enforceable under the sale of business exception. Ultimately, the court found that the three-year non-compete agreement in the stock purchase agreement was sufficiently tied to the sale of the business and thus was valid and enforceable under the exception.

On the other hand, the court decided that the one-year provision in the employment agreement was not sufficiently tied to the sale of the business. The court reasoned that unlike the stock-purchase agreement that had a non-compete term immediately following the acquisition, the employment agreement had a non-compete term that was tied to Maas' termination of employment. Thus, the employment agreement's non-compete clause had nothing to do with protecting the buyer's interest in preserving the value of the business. Therefore, the non-compete agreement did not fall within the exception and was unenforceable.

Since Maas had already satisfied the three-year non-compete provision in the stock purchase agreement, the court declared him free to work for his new employer.

Consult an attorney

The lesson of the Maas case is that acquiring business that wish to secure an enforceable non-compete agreement must carefully integrate the non-compete provisions into the deal documents. Unless the deal documents are carefully drafted, the non-compete provisions run the risk of being unenforceable under California law. It is therefore important that businesses considering an acquisition of another company consult with an experienced business litigation attorney to ensure that the purchase documents are adequately drafted.

Article provided by Brown & Charbonneau, LLP
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