California Supreme Court Clarifies Bounds of Legitimate Competition Under Tort and Antitrust Law
On August 3, 2020, the California Supreme Court issued its highly anticipated decision in Ixchel Pharma, LLC v. Biogen, Inc., clarifying the bounds of legitimate competition under California tort and antitrust law. The Court’s ruling generally came down in favor of encouraging competition, reducing claims for tortious interference with contract, and decreasing the risk of litigation arising from normal competitive activity. There are two significant takeaways for California businesses from the Ixchel opinion:
·The Court toughened the pleading requirements of a claim for tortious interference with an at-will contract, requiring that a plaintiff plead that interference with any at-will contract, even outside the employment context, was independently wrongful, i.e., unlawful over and above its interference with an enforceable contract. The Court reasoned that at-will contracts do not involve the same “cemented economic relationships” as contracts with a definite term. To protect their contracts from interference by third parties, California businesses will be well-advised to require a fixed term, or other concrete milestones that the counter-party is contractually required to perform.
The Court further made clear that California’s ban on covenants not to compete under Business and Professions Code section 16600 extends beyond noncompetition agreements following the termination of employment or the sale of an interest in a business. The Court held, however, that section 16600 does not impose a per se prohibition of contractual restraints on business operations and commercial dealings outside these areas, but rather that such restraints are governed by the “rule of reason,” i.e., “whether the challenged conduct promotes or suppresses competition.” This should reduce the risk of litigation arising from common commercial arrangements such as franchise and exclusive dealing agreements.
Plaintiff Ixchel Pharma, LLC (Ixchel), a biotechnology company, entered into an agreement with Forward Pharma (Forward) to jointly develop a drug for the treatment of a disorder called Friedreich’s ataxia. The drug development went according to plan until Forward decided to withdraw from the agreement, as was allowed by its terms. California’s Supreme Court was careful to recognize that the Forward/Ixchel agreement was terminable “at-will,” and not a “cemented economic relationship.” Pursuant to a settlement with another biotechnology company, defendant Biogen, Inc. (Biogen), Forward agreed to terminate its contract with Ixchel.
Ixchel sued Biogen in federal court for tortiously interfering with Ixchel’s contractual and prospective economic relationship with Forward and claimed that Biogen did so in violation of Business and Professions Code section 16600. On appeal, the United States Court of Appeals for the Ninth Circuit certified two questions to the California Supreme Court: (1) “Does section 16600 of the California Business and Professions Code void a contract by which a business is restrained from engaging in a lawful trade or business with another business?” (2) “Is a plaintiff required to plead an independently wrongful act in order to state a claim for intentional interference with a contract that can be terminated by a party at any time, or does that requirement apply only to at-will employment contracts?”
Reasoning that the questions are interrelated, as a violation of section 16600 was the independently wrongful act alleged in Ixchel’s contractual interference claim, the California Court rephrased and reordered the questions as follows: (1) “Is a plaintiff required to plead an independently wrongful act in order to state a claim for tortious interference with a contract that is terminable at-will? (2) What is the proper standard to determine whether section 16600 voids a contract by which a business is restrained from engaging in a lawful trade or business with another business?”
Tortious Interference With At-Will Contracts
California has traditionally recognized two economic relations torts: interference with the performance of a contract and interference with a prospective economic relationship. The two torts are related but distinct. Tortious interference with contractual relations requires (1) the existence of a valid contract between the plaintiff and a third party; (2) the defendant’s knowledge of that contract; (3) the defendant’s intentional acts designed to induce a breach or disruption of the contractual relationship; (4) actual breach or disruption of the contractual relationship; and (5) resulting damage. It is generally not necessary that the defendant’s conduct be wrongful apart from the interference with the contract itself. Tortious interference with prospective economic advantage, on the other hand, does not depend on the existence of a legally binding contract. Rather, a plaintiff must show the defendant knowingly interfered with an “economic relationship between the plaintiff and some third party, [which carries] the probability of future economic benefit to the plaintiff.”
Both of these torts are intended to protect the public interest in stable economic relationships. In Ixchel, the Court explained that courts provide a remedy against conduct intended to disrupt an existing contract because such a “formally cemented” economic relationship is worthy of protection from interference by a third party. However, economic relationships that are less than contractual are deserving of less protection, because the law generally draws lines of legal liability in a way that maximizes competition. Imposing an independent wrongfulness requirement on claims for interference with prospective advantage thus strikes a balance “between providing a remedy for predatory economic behavior and keeping legitimate business competition outside litigative bounds.”
The Court reasoned that at-will contracts are more akin to prospective economic relations than “formally cemented” contracts with a specified term. An at-will contract may be terminated, by its terms, at the prerogative of a single party, whether because that party found a better offer from a competitor, decided not to continue doing business, or for any other reason. Neither party has a legal claim to continued relations with the other. Because the expectation of future relations is weaker and the interest in maintaining open competition is stronger, “the law usually takes care to draw lines of legal liability in a way that maximizes areas of competition free of legal penalties.” When parties have no legal assurance of future relations, “the rewards and risks of competition are dominant.” The Court further emphasized that allowing interference with at-will contract claims without requiring independent wrongfulness risks chilling legitimate business competition; for example, without an independent wrongfulness requirement, a competitor’s good faith offer to provide goods or services at a lower price, which causes a business to withdraw from an at-will contract, could trigger liability or at least subject the competitor to costly litigation.
The Supreme Court, therefore, held that to state a claim for interference with an at-will contract by a third party, the plaintiff must allege that the defendant engaged in an independently wrongful act. The Court sent a strong message to California contracting parties: If they want to protect contractual relationships from interference by outsiders, California businesses should explicitly state the term of the agreement, or make it clear that the agreement cannot be terminated simply at the will of one of the parties. Doing so should entitle the contract to the more rigorous protections historically afforded to “cemented economic relationships.”
Business and Professions Code Section 16600
The language of Business and Professions Code § 16600 is broad on its face: “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 plain text suggests that any part of an agreement restraining a party from engaging in a trade, profession, or business is per se invalid unless certain exceptions apply. Historically, the statute has been applied as a per se bar (with certain statutory exceptions) to non-compete provisions found in employment agreements, or restrictive covenants that are incident to the sale of a business. The Court left the body of law around those two issues untouched.
The Ninth Circuit initially certified a limited question to the California Court: “Does section 16600 of the California Business and Professions Code void a contract by which a business is restrained from engaging in a lawful trade or business with another business?” Ixchel asked the Court to decide that question only. Noting that at oral argument Biogen had conceded that section 16600 applies to business contracts, and that “the proper standard governing alleged restraints of trade under section 16600 presents an important question of California law, potentially affecting all contracts in California that in some way restrain a contracting party from engaging in a profession, trade, or business,” the Supreme Court addressed not only whether section 16600 applies to contracts in the business context, but also the proper standard to evaluate whether restraints on trade in business contracts are void under section 16600.
Examining the history of the statute, the case law, the related statutory provisions of California’s antitrust law in the Cartwright Act, and the practical effects of a strict interpretation of the statute, the court determined that would not disturb the judicial decisions strictly interpreting section 16600 to invalidate noncompetition agreements following the termination of employment or sale of interest in a business. However, with respect to contractual restraints on business operations and commercial dealings, the Court held a “rule of reason” should apply: “whether an agreement harms competition more than it helps,” considering the facts concerning the business in which the restraint is applied, the nature and effects of the restraint, its history, and the reasons for its adoption.
In particular, the Court was mindful of the consequences of strictly interpreting the language of Section 16600 to invalidate all contracts that limit the freedom to engage in commercial dealing. The Court recognized that exclusive dealing arrangements are often a part of franchise agreements or a distributorship contracts where, in exchange for the right to sell the franchisor’s products, franchisees agree to purchase from a particular supplier or operate in a particular geographic area. These agreements may have procompetitive effects. They may provide an incentive for the marketing of new products and a guarantee of quality-control.
In sum, the Supreme Court held that a rule of reason applies to determine the validity of contractual provisions by which a business is restrained from engaging in a lawful trade or business with another business. The decision recognizes the ruinous effect that per se application of Section 16600 to long-accepted business arrangements would have on California’s economy, and should reduce the risk of litigation arising from well-accepted commercial arrangements such as franchises and other exclusive dealing agreements.