Non-Compete Clauses are Not Strictly Void in B2B Agreements

The California Supreme Court ruled recently that Business & Professions Code § 16600 does not mean what it says: “[absent an express exception], every contract by which a business is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.” At least not in the business context.

In Ixchel Pharma, LLC v. Biogen, Inc. (2020) 9 Cal.5th 1130, the Supreme Court held that contractual restraints on business operations are not void but subject to a reasonableness standard (a rule of reason) under section 16600. However, not that long ago, the Supreme Court held that “[s]ection 16600 is unambiguous, and if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect.” Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937. Wait, what?

The Supreme Court reconciled its seemingly contradictory rulings by: 1. Limiting Edwards and similar decisions, holding that restraints of trade in all contexts were void, to the facts of the case; 2. Relying on decisions decided before the enactment of section 16600 that declined strictly to void agreements that restrained trade; and 3. By treating the interpretation of section 16600 the same as the virtually identical sections 16722 and 16723 of the Cartwright Act that are subject to a rule of reason.

Now, a business agreement that limits competition is invalid only “if it harms competition more than it helps it.” This rule of reason requires courts to make a factual determination based on such things as the reasons for the restraint and its effects. See, Sandler Partners, LLC v. Masergy Communs., Inc. (2021) 848 Fed.Appx. 798. This analysis may even require expert testimony about the relevant market and the defendant’s market power. Id.

Takeaway: Competition can lead to anticompetitive agreements that benefit both businesses and consumers even though it interferes with the contracts and prospective business of others. In Ixchel, the Supreme Court has cleared the path for businesses to enter into such anti-competitive agreements so long as they are reasonable.