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California Supreme Court Issues Decision in Ixchel Pharma, LLC v. Biogen, Inc.: Rule of Reason Will Apply to Non-Compete Agreements Between Businesses

With few exceptions, California Business and Professions Code section 16600 protects the right of an individual to compete with his or her former employer and invalidates many non-compete agreements.  In a new decision, Ixchel Pharma, LLC v. Biogen, Inc.held that the common law rule of reason governs most non-compete covenants between businesses.  The court also held that a claim for tortious interference with an at-will arrangement between businesses requires evidence of an independent wrongful act.

Background

The decision arose out of a dispute involving three biotech companies — Forward, Ixchel and Biogen.  Forward and Ixchel had agreed to work together to develop a new drug, but Forward terminated the contract — as was its right — to enter into a new and exclusive contract with Biogen.  Under the new contract, Forward agreed to avoid all new partnerships with companies dealing in similar biotech products.  In response, Ixchel sued Biogen in federal court, alleging that the Forward-Biogen contract was an unenforceable non-compete agreement under Business and Professions Code section 16600, as it restrained Forward from engaging in lawful future business with Ixchel.  Ixchel further alleged that Biogen tortiously interfered with its at-will contract with Forward. 

After losing in the district court, Biogen appealed to the Ninth Circuit, which asked the California Supreme Court to decide (1) “how Business and Professions Code section 16600 applies to the [contract] requiring Forward to terminate its agreement with Ixchel” and (2) “whether Biogen’s interference in Ixchel’s at-will contract with Forward must be independently wrongful[.]”

Holding

With respect to the first question posed by the Ninth Circuit, the California Supreme Court held that section 16600 does apply to contracts between businesses.  However, unlike the approach to non-compete agreements in the employer/employee context, the Court held that non-compete provisions in agreements between businesses are analyzed under a reasonableness standard.

Rejecting Ixchel’s argument that the plain meaning of the statute and other statutory analogs forbids constraints on “anyone” without caveat, the Supreme Court held that “[i]n context, section 16600 is best read not to render void per se all contractual restraints on business dealings, but rather to subject such restraints to a rule of reason.”[1]  The court reasoned that in interpreting the California Civil Code predecessor to section 16600, the court always had “declined to categorically invalidate all agreements limiting the freedom to engage in trade.”[2] Furthermore, the court looked to the state Cartwright Act, which shares both a “statutory purpose and doctrinal heritage in common law prohibitions on restraints of trade” with section 16600,[3]and held that the two statutes should be harmonized.  Key to the court’s decision was the potential and practical impact of invalidating all trade agreements between businesses.  It recognized the pro-competitive advantages of using reasonable trade limitations to build stable predictable partnerships between complimentary businesses. Thus, the court held that agreements limiting commercial dealings and business operations are invalid only if they are unreasonable under the common law test.  Under that test, “‘courts will not hold to be in restraint of trade a contract …, the main purpose and effect of which are to promote and increase business in the line affected, merely because its operations might possibly in some theoretical way incidentally and indirectly restrict trade in such line.’”[4]  The court did not opine on whether the Forward-Biogen contract was permissible under the rule of reason, leaving that for the federal courts to decide.

As for the Ninth Circuit’s other question, the Supreme Court held that the tort of interference with a prospective economic relationship (rather than the tort of tortious interference with contractual relations) applies to an at-will relationship, that the tort requires proof of an independent wrongful act, and that the tort is not limited to employment disputes and also extends to other at-will business contracts.  “The purpose of the independent wrongfulness requirement in economic interference torts is to ‘balance between providing a remedy for predatory economic behavior and keeping legitimate business competition outside litigative bounds.’”[5]  To allow claims to proceed for interference with at-will contract claims without requiring independent wrongfulness “risks chilling legitimate business competition.”[6]

What Next?

The Supreme Court’s opinion will come as a relief to companies that use non-compete covenants in joint ventures, leases, distribution agreements, license agreements, and other contracts.  While these contracts are still subject to scrutiny under section 16600, they will not be invalidated if they satisfy the rule of reason.  Prudent companies now will reassess their agreements to ensure they are defensible with the rule of reason. 

The decision will also provide protection against efforts to recruit businesses—like employees—subject to an at-will agreement, so long as no independently wrongful conduct is involved.


[1]   Ixchel Pharma, LLC v. Biogen, Inc., No. S256927, slip op. at 22 (Cal. Aug. 3, 2020).

[2]   Id. at 23.

[3]  Id. at 38.

[4]  Id. at 30 (quoting Great Western Distillery Products v. John A. Wathen Distillery Co., 10 Cal. 2d 442, 446 (1937).

[5]  Ixchel, slip op. at 9 (quoting Della Penna v. Toyota Motor Sales, U.S.A., Inc., 11 Cal. 4th 376, 378 (1995).

6 Id.


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