California Strikes Down Overly Restrictive Non-Competition Provision Related To Sale Of Business

California's deeply rooted public policy has long favored free competition and generally weighed against the enforceability of non-competition agreements. Section 16600 of the California Business and Professions Code provides that "... every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void." There are, however, a number of limited statutory exceptions to the general rule. One such exception—found in Business and Professions Code §16601—provides that limited covenants not to compete are enforceable in connection with the sale of a business.1 The commercial principle underlying the exception is to protect the goodwill and value of the business acquired by the buyer against competition from the seller that would otherwise diminish such value.

The California Court of Appeal (the "Court"), in Fillpoint, LLC v. Maas (August 24, 2012), considered the validity of two different covenants not to compete that were entered into in connection with the sale of a business: first, a three-year restriction on a selling shareholder's ability to compete following the closing of the transaction contained in the purchase agreement for the business, and second, a one-year restriction on the same selling shareholder's ability to compete following termination of the shareholder's employment with the purchaser, which covenant was contained in an employment agreement. The Court determined that, while the three-year restriction following closing contained in the purchase agreement (and which had already been fulfilled) fell within the §16601 exception, the one-year post-termination restriction contained in the employment agreement was overly burdensome and, as such, void and unenforceable.

Facts and Background

Michael Maas was an employee and stock owner of Crave Entertainment Group, Inc., ("Crave"), a video game publisher and distributor, when it was acquired by Handleman Company ("Handleman") in October 2005. The stock purchase agreement by which Handleman acquired Crave and which was entered into by Maas, other Crave stockholders and Handleman, included a covenant not to compete. The covenant not to compete prohibited the Crave stockholders, including Maas, from engaging in video game publication and distribution competitive to Handleman for three years following the closing date.

In connection with the sale of Crave to Handleman, Maas entered into an employment agreement with Crave...