When Are Non-Compete Agreements Valid in California?
On August 29, 2019, in Quidel Corporation v. Superior Court of San Diego County (Cal. Ct. App., No. D075217) 2019 WL 4071848 (“Quidel”), the California Court of Appeal, Fourth Appellate District, Division 1, clarified when noncompetition agreements are lawful in California following its Supreme Court’s watershed decision concerning those contracts in Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937 (Edwards).
Background of the Noncompetition Agreement at Issue
Quidel Corporation (Quidel) was the successor in interest to a company called Biosite, which originally held the exclusive right under a 1990s licensing agreement to develop an immunoassay to determine the level of B-type natriuretic peptide (BNP) in a person’s blood sample, to help diagnose congestive heart failure. After acquiring intellectual property rights and know-how, Biosite developed and created a BNP assay for use with its point-of-care analyzer device and it obtained regulatory approval. BNP assays only work on the analyzer for which they are designed.
By 2003, Beckman Coulter, Inc. (Beckman) had developed a laboratory analyzer, but it did not have a license for a BNP assay compatible with its analyzer. Around this same time, other companies were also pursuing BNP assays for use with their larger analyzers, which could run multiple, different immunoassays at higher volumes than the point-of-care analyzer Biosite had. Additionally, another competitor was also developing an assay to detect NT-proBNP, a closely-related assay that was a potential direct substitute for the BNP assay.
If Biosite were to correlate a new BNP assay for use with the Beckman lab analyzer to its FDA-approved BNP assay, it could obviate the need to establish the new assay’s efficacy through extensive clinical trials. A Biosite-Beckman collaboration would mean Biosite could expand its customer base to those who wanted to use the larger capacity laboratory analyzers and Beckman could include the BNP assay in its immunoassay offerings.
Each represented by legal counsel, Biosite and Beckman negotiated their BNP Assay Agreement (the “Agreement”) over several months, and they exchanged numerous drafts before executing it in 2003. Under the Agreement, Beckman manufactured the BNP assay for Biosite using proprietary materials that Biosite provided, including the antibodies Biosite had developed. In exchange, Biosite exclusively purchased its requirements of the BNP assay from Beckman. The Agreement prohibited Biosite from engaging other manufacturers to provide the BNP assay for their competing lab analyzers. The term of the Agreement was negotiated to coincide with the term of a related licensing agreement that Biosite had with a third party.
The Agreement requires Beckman to offer for sale and to sell the BNP assay exclusively to Biosite. The Agreement also prohibits Beckman from researching or developing an assay that detects the presence or absence of the BNP or NT-proBNP proteins or markers for use in diagnosing cardiac disease until two years before the Agreement’s expiration. It does not prohibit, however, the research or development of assays that detect the presence or absence of other proteins or markers.
In 2017, Beckman sued Quidel for declaratory relief alleging violation of California Business & Professions Code section 16600 and the Cartwright Act (Business & Professions Code § 16720 et seq.). Beckman asked the trial court to issue a declaratory judgment that the noncompete language of the Agreement was void and unenforceable under Business and Professions Code section 16600, and to issue a permanent injunction preventing the enforcement of that portion of the Agreement.
In 2018, Beckman filed a motion for summary adjudication on its declaratory relief cause of action. In its papers, Beckman stated it was planning to launch a new laboratory analyzer platform and wanted to develop a competing assay product for the new platform. It argued the Agreement’s covenant not to compete was void under Business and Professions Code section 16600.
The trial court granted Beckman’s motion for summary adjudication. It noted that none of the statutory exceptions to section 16600’s prohibition on the restraint on trade applied. The court further explained that it was unpersuaded by the legal authority cited by Quidel because it either predated Edwards or discussed exclusive dealing contracts in the confines of franchise relationships. Relying on Edwards, the trial court concluded that section 16600 voids “every contract” that restrains “anyone” from “engaging in a lawful profession, trade, or business of any kind . . . . ” According to trial court, the Agreement’s noncompete language was void because it “restrains [Beckman] from developing, marketing, or assisting others in the development and marketing of an assay that measures or detects the presence or absence of BNP or NT-proBNP.”
On January 18, 2019, Quidel filed a petition for writ of mandate and/or prohibition with the Court of Appeal and sought a stay of litigation pending a determination of the writ on its merits. The appellate court issued an order to show cause why a peremptory writ should not issue and stayed the order granting Beckman’s motion for summary adjudication pending further proceedings.
Quidel argued that in the context of an exclusive dealing business arrangement between two corporate entities, a court should consider whether an in-term noncompetition provision promotes competition or restrains it, taking into consideration a multi-factor test that contemplates the purposes, effects, or reasonableness of the provision’s restraint. Beckman, on the other hand, urged the court to deny the writ on its merits and uphold the superior court’s application of the Supreme Court’s holding in Edwards that “[n]oncompetition agreements are invalid under section 16600 in California, even if narrowly drawn, unless they fall within the applicable statutory exceptions of [Business & Professions Code] sections 16601, 16602, or 166025.” (Edwards, supra, 44 Cal.4th at p. 955.)
The Court of Appeal was presented with the following question: “Does section 16600 invalidate all contractual noncompete provisions, even outside the employment context, without regard to the reasonableness of the restraint imposed or whether the terms actually advance, rather than restrain, competition?”
Certain Business-to-Business Covenants Not to Compete May Survive Section 16600 Scrutiny
The Court of Appeal issued an opinion granting Quidel’s petition and directing the trial court to vacate its order granting Beckman’s motion for summary adjudication.
The appellate court began its opinion by affirming that in the employment realm Edwards’ holding remains the law—courts will strictly apply section 16600’s prohibition against restraints on trade. But, the Quidel court found that under the Agreement no individual’s ability to seek employment is impacted by the non-competition provision. The Agreement fell outside the confines of Edwards because it does not restrict an individual’s ability to engage in a profession, trade, or business.
Outside the employment context there are limited situations when non-competes may be enforceable. Although no published cases since Edwards had addressed the application of the presumptive rule announced there outside the employment environment, in case law predating Edwards, California courts have held that noncompetition clauses are valid outside concerns with employment. Reviewing numerous cases going back decades, the Quidel court held that “as long as a noncompetition provision does not negatively affect the public interests, is designed to protect the parties in their dealings, and does not attempt to establish a monopoly, it may be reasonable and valid.”
“In-term” Covenants Not to Compete May Also Be Valid
Though likely not part of its central holding in Quidel, the Court of Appeal also drew a distinction between the post-term use of the employment noncompete in Edwards and the in-term covenant not to compete in Quidel. The Court of Appeal held that “in-term covenants not to compete in exclusive dealing agreements are not per se invalid” so long as they are used in a non-employment context.
Ultimately, the Quidel court decided that whether the Agreement tended to restrain trade more than promote it remains unclear and requires a factual analysis, such that summary adjudication of Beckman’s declaratory relief claim was inappropriate. The court also found that whether the Agreement is necessary to protect the parties in their dealings similarly requires a factual analysis, and the record on this issue was incomplete. Further, the parties also had not factually developed whether the Agreement forecloses a substantial share of a line of commerce. As stated by the court, “[b]ecause we have concluded that the rule announced in Edwards does not extend beyond the employment context, we conclude such factual development is relevant and necessary here.”
When Non-Compete Agreements Are Valid Under California Law
To summarize, California permits non-competes in the only following very limited situations, where:
Any person sells the goodwill of a business, or any owner of a business entity sells or otherwise disposes of all of his or her ownership interest in the business entity, or any owner of a business entity sells (a) all or substantially all of its operating assets together with the goodwill of the business entity, (b) all or substantially all of the operating assets of a division or a subsidiary of the business entity together with the goodwill of that division or subsidiary, or (c) all of the ownership interest of any subsidiary. (Bus. & Prof. C., § 16601.)
Partners dissolve a partnership, or when one or more partners dissociate from the partnership. (Bus. & Prof. C., § 16602.)
A member of a limited liability company (LLC) on or in anticipation of dissolution of or the termination of his or her interest in the LLC. (Bus. & Prof. C., § 16602.5.)
Under Quidel, businesses may now be able add to the short list of lawful covenants not to compete those outside the employment context that (1) do not negatively affect public interests, (2) are designed to protect the parties in their exclusive dealings, and (3) do not establish a monopoly.
Quidel may not be a sea change in competition law; it’s mostly a reminder by one California Court of Appeal about case law of an older vintage that many had forgotten or largely disregarded, particularly after the wake-up call of Edwards. But it offers an interpretation of Section 16600 and Edwards that is welcome for businesses seeking to protect their investments vis-à-vis sophisticated counterparties. There will no doubt be circumstances where the Quidel test proves vague or unwieldy in its application. Appropriate legal counsel is advised. And, it’s unknown at the time of this article’s publication whether Beckman will appeal the decision to the California Supreme Court or whether that court will agree to even hear further appeal. Stay tuned for whether the Court of Appeal’s test survives California Supreme Court analysis, or whether the high court adopts or modifies it.
For the time being, however, there is solace in knowing that prior sentiment—widespread throughout California’s legal community—that Edwards imposed a strict prohibition against all non-competes not specifically exempt under the Business & Professions Code, has proven to be unwarranted in non-employment realms.
*Shanen practices business and intellectual property law at the Law Office of Shanen R. Prout in Los Angeles, California. His firm provides counseling, transactional, and civil litigation services to businesses in the e-commerce, manufacturing, retail, apparel and accessory, entertainment, events services and production, art, and food services industries, among others.
© 2019, Shanen R. Prout. All rights are reserved.