California Supreme Court Applies Rule of Reason Test for “Business Only” Restrictive Covenants
In Ixchel Pharma, LLC v. Biogen, Inc., 20 Cal. Daily Op. Serv. 7729, __ P.3d __(August 3, 2020), the California Supreme Court made it easier for businesses to enforce restrictive covenants against other businesses. This holding is a directional shift for the Court which had previously narrowly construed the applicable statute (California Business & Professions Code § 16600) when addressing employee mobility issues.
Ixchel sued Biogen in federal court and alleged Ixchel entered into a Collaboration Agreement with Forward to develop a new drug that contained dimethyl fumarate (DEF), which authorized Forward to terminate the agreement at any time on 60 days’ notice. During the same time period, Forward negotiated a $ 1.35 billion settlement and license agreement with Biogen in exchange for certain Forward intellectual property. Section 2.13 of that agreement required Forward to terminate any agreement with Ixchel that related to DEF development. Forward terminated the Ixchel agreement and Ixchel lost its ability to develop its product.
The operative complaint alleged the Biogen-Forward agreement was a restraint of trade in violation of § 16600, which states “except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” The district court dismissed the complaint finding the Biogen-Forward agreement must be analyzed under the antitrust rule of reason and that § 16600 does not apply outside of the employment context.
Ixchel appealed to the Ninth Circuit and after oral argument, the Court certified two questions to the California Supreme Court, which rephrased the questions as: (1) Is the Plaintiff required to plead an independently wrongful act to state a claim for tortious interference of an at will contract and (2) What is the proper standard to determine whether § 16600 voids a contract by which one business is restrained from engaging in another lawful business? The alleged violation of § 16600 was the independent wrongful act in Ixchel’s tortious interference claim.
In Reeves v Hanlon (2004), 33 Cal 4th 1140, the Court answered issue (1) affirmatively in the employment context and in Ixchel it extended that holding to all at will contracts.
In Edwards v Arthur Andersen (2008), 44 Cal 4th 937, the Court, in the employment context, held there was no limited restraint exception to § 16600 and rejected any reasonability analysis.
Ixchel argued that Edwards was controlling and therefore the rule of reason standard should not apply in the non-employment context. The Court rejected this argument, finding that this issue was not presented in Edwards and employee mobility presents different policy considerations than business disputes. The Court held the rule of reason applies to determine the validity of a contractual provision by which a business is restrained from engaging in a lawful trade or business with another business, and further holding that Section 2.13 of the Biogen-Forward agreement is such a restraint.
In so ruling, the California Supreme Court made it easier for businesses to enforce restrictive covenants against other businesses.