California Courts Narrowly Construe Covenants Not to Compete

As mentioned previously in this space, over the last several years California courts have narrowed an employer’s ability to restrict employee activities after termination, culminating with the California Supreme Court’s decision in Edwards v. Arthur Andersen LLP (2008) 44 Cal.4^th 937.  In Edwards, the Supreme Court announced the general rule that all covenants not to compete were void, subject to limited statutory exceptions.  Recently, a California appellate court looked at one of the statutory exceptions, Business and Professions Code section 16601’s sale-of-business exception.

In Fillpoint, LLC v. Maas (2012) 208 Cal.App.4^th 1170, the court considered whether an employment agreement containing a covenant not to compete is permissible when executed contemporaneously with a stock purchase agreement.   As part of a stock sale of his company “Crave Entertainment Group, Inc.”, the Defendant employee (Maas) agreed to a three-year covenant not to compete with the buyer.   Maas also agreed to stay on and work for Crave after the stock purchase and signed an employment agreement containing a one-year covenant not to compete that was not operative until he ceased working for Crave.  Three years after consummating the stock purchase, Maas resigned from Crave and six months later began working for a competitor of Crave.  Crave’s subsequent purchaser, Fillpoint, then sued Maas for breaching his employment agreement not to compete for one year following the termination of his employment with Crave.

Although the Fillpoint court agreed with Fillpoint (Crave) that the stock purchase agreement and the employment agreement must be read together, the court pointed out that by their very nature, the restrictions in covenants not to compete in a stock purchase agreement were different from those in an employment agreement.  Whereas the “purchase agreement’s covenant was focused on protecting the acquired goodwill for a limited period of time,” the “employment agreement’s covenant targeted an employee’s fundamental right to pursue his or her profession.”  Accordingly, Fillpoint held that the employment agreement’s covenant not to compete did not fit within the limited exception contained in Business and Professions Code section 16601’s sale-of-business exception, and was, therefore, unenforceable.

Fillpoint serves as a reminder that courts will strictly construe employment agreements containing covenant’s not to compete, even when they are executed in the context of other events.  As such, employers should be mindful that such covenants will rarely, if ever, be upheld, and then only in the narrowest of circumstances.