September 20, 2012
On August 24, 2012, in the case of Fillpoint, LLC v. Maas, a California appellate court issued an opinion reinforcing both California’s general public policy against covenants not to compete and the important exceptions to that rule. While California Business and Professions Code § 16600 generally declares void any covenant that restrains an individual from engaging in a lawful profession, trade or business, § 16601 provides an exception to this rule for covenants executed in connection with the sale of a business. The Fillpoint case instructs that, to qualify for § 16601’s sale-of-business exception, employers must thoroughly document and tether any non-compete covenant to the sale of a business.
Fillpoint: Factual Background.
In Fillpoint, Michael Maas worked for and owned stock in Crave Entertainment Group, Inc., a video game distribution and publishing company. When Handleman Company acquired Crave in 2005, Maas entered into a stock purchase agreement with Handleman, selling his stock in Crave to Handleman and agreeing to a three-year covenant not to compete, measured from the date of sale. As part of the stock purchase transaction, Maas entered into a three-year employment agreement with Crave which included a covenant not to compete or solicit customers or employees for one year following the expiration of the employment agreement or the earlier termination of Maas’s employment. Maas resigned exactly three years after the employment agreement was signed, thus fulfilling the three-year term of the employment agreement and the three-year non-compete provision of the stock purchase agreement. Approximately six months later, Maas became the president and CEO of Solutions 2 Go, a competitor of Crave. Fillpoint, LLC, the assignee of Crave’s rights under the employment agreement, sued Maas for breach of that agreement’s non-compete provision.
Following Fillpoint’s opening statement at trial, defense counsel moved for a nonsuit, arguing that the employment agreement’s one-year non-compete was not enforceable. The trial court granted the motion, and Fillpoint appealed.
The Fillpoint Court’s Analysis.
The California Court of Appeal for the Fourth District first considered whether the stock purchase agreement and the employment agreement must be read together. Observing that the two agreements were between the same parties, the agreements referenced each other, and the employment agreement contained an integration clause providing that the terms of the stock purchase agreement would prevail in the event of a conflict, the court found that the agreements must be read together as an integrated agreement. In so doing, the court rejected the contention that § 16601 required that a non-compete covenant be contained in a merger or acquisition document to qualify for the sale-of-business exception; instead, the covenant must merely be executed "in connection with" the sale of the business.
The court then turned to the enforceability of the employment agreement’s one-year covenant not to compete. The court found that this provision was not sufficiently linked to the protection of Crave’s goodwill to invoke the § 16601 sale-of-business exception. Unlike the stock purchase agreement’s three-year covenant, which protected the goodwill of Crave and "served the purpose" of § 16601, the employment agreement’s one-year covenant was much broader and "affected Maas’s rights to be employed in the future," thereby "targeting [his] fundamental right to pursue [his] profession."
Finally, the court stated that the nonsolicitation terms in the employment agreement were unenforceable. Specifically, the court reasoned that the employment agreement’s restriction on the solicitation of potential customers was "too broad" and inconsistent with the purpose of § 16601. The court did not comment separately on the nonsolicitation of employees provision. Because Fillpoint never contended that Maas had violated the nonsolicitation of employees clause of the employment agreement, this latter portion of the ruling would likely be considered dicta with limited precedential value.
Implications of Fillpoint under Current California Law.
The Fillpoint case has several implications for the current status of California law as it relates to restrictive covenants:
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