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Business Law by Tom Ramsey

Limiting Covenants Not To CompeteTom Ramsey - Business Law

July 2nd, 2013 – Under California law, covenants not to compete are generally unenforceable. An exception to this rule is stated in the California Business & Professions Code, which permits the enforcement of such covenants when they are entered into in connection with the sale of a business, because they protect the goodwill of the business being sold.

To no one’s surprise, enterprising individuals continually explore ways to get around this restriction.

In 2005, Michael Maas was employed by Crave Entertainment Group, Inc. He was also a shareholder. In connection with the sale of his stock to Crave, he agreed not to compete with Crave for three years. So far, so good.

After the sale, Michael remained a Crave employee pursuant to an employment with Crave. The employment agreement contained a separate, and additional, one-year covenant not to compete. The one-year period would start to run when Michael’s employment with Crave ended.

Three years later, Michael resigned as a Crave employee. By then, the three-year covenant not to compete, set forth in the stock purchase agreement, had expired. All that remained was the one-year covenant not to compete that was contained in the employment agreement.

About six months later, Michael began working for Solutions 2 Go, Inc., a competitor of Crave. Parenthetically, during this period, the ownership of Crave changed, as did its name. However, to keep the story simple, the employer’s identity will remain as “Crave.”

Crave sued Michael for breaching his employment agreement. For good measure, Crave also sued Solutions 2 Go, Inc., for interference with the noncompetition provisions of Michael’s employment agreement.

At this point in time, the only basis for Crave’s lawsuit would be the one-year covenant not to compete. Unless it satisfied the exception contained in the Business and Professions Code, it is unenforceable: It depended entirely on the provisions of the California Business and Professions Code for its survival.

Michael and Solutions 2 Go, Inc., prevailed at the trial court level. The trial court found that this covenant was not enforceable.

Crave appealed.

The Court of Appeal decided that since the stock purchase agreement and the employment agreement are part of a single transaction, they must be read together. As it would turn out, determining that the two agreements are part of a single transaction would be of no assistance to Crave.

Crave contended that since both agreements must be read together, the one-year covenant is part of value received by Crave from the sale of its stock by Michael. It therefore fell within the exception and should be enforced.

The Court of Appeal found that the restrictions in the two covenants not to complete were rather different.

First, the agreement tied to the sale of Michael’s stock was focused on protecting Crave’s goodwill. It prevented Michael from setting up or assisting someone else in setting up a business to compete with Crave. This covenant not to compete protected the goodwill of Crave for three full years and fit within the provisions of the Business and Professions Code allowing such covenants.

By contrast, the employment agreement’s covenant not to compete was much broader. It prevented Michael from making sales contacts or making actual sales to anyone who was Crave’s customer or potential customer during the two years prior to the termination of Michael’s employment or assisting others in doing so. It also prevented Michael from working for or owning an interest in any business that was in the same business as, or would compete with, Crave. Finally, it prevented Michael from employing or soliciting for employment any of Crave’s employees or consultants. This set of restrictions had nothing to do with protecting Crave’s goodwill. It affected Michael’s right to be employed in the future and, in this case, for a year after the end of the three-year period of the purchase agreement’s covenant.

The Court of Appeal concluded that the employment agreement’s covenant not to compete was targeted at Michael’s fundamental right to pursue his profession. As such, it is not enforceable.

The judgment of the trial court was affirmed.

The case is entitled Fillpoint, LLC v. Maas. It was decided in 2012.

(Tom Ramsey is a Long Beach attorney who has specialized in business law for more than 40 years. He may be reached at bizlawwiz@aol.com.)