California Appeals Court Rules in Business Sale Lawsuit

California law generally prohibits the enforcement of non-solicitations, but the law includes a narrow exception related to the sale of a business. In Blue Mountain Enterprises, LLC v. OwenIn a recent decision by the California State Court of Appeals, First Appellate District, the Court of Appeals upheld a decision in favor of the purchaser of a business under this exception.

California Business and Professions Code, Section 16600

In California, contractual provisions that prevent a person from practicing an occupation, trade, or business are generally invalid Business and Professional Code Section 16600. As the California Supreme Court has noted, “Section 16600 demonstrates a firm legislative policy in favor of open competition and worker mobility.”

California courts have ruled that this statute prohibits the enforcement of non-compete agreements, customer non-solicitations, and perhaps even employee non-solicitations. While employers can often successfully enforce these types of restrictive agreements in other states, enforcement in California is not guaranteed.

But there is one important exception to this law. Section 16601 states: “Any person who sells the goodwill of a business, or any owner of a business entity who sells or otherwise disposes of his or her entire interest in the business entity… may agree with the purchaser to discontinue a similar business in a particular.” geographic area in which the business so sold, or that of the business unit, division or subsidiary operated, so long as the buyer … operates a similar business there.”

This exception became the central theme in the blue mountain case, described below.

A Californian sells his business, Agrees not to court…but then gets fired and pleads

The dispute in blue mountain originated from a transaction in which a business owner, Gregory Owen, sold his heating, ventilating and air conditioning (HVAC) business to an investment group. The transaction comprised four contracts and took place in several steps. First, Owen transferred his entire interest in ownership to a newly incorporated limited liability company (LLC). Owen owned 100 percent of the new LLC at inception, but four days later the investment group bought 50 percent of that LLC, for which Owen received $3 million. Owen kept the other 50 percent. In a concurrent employment contract with the LLC, Owen agreed to serve as the new company’s chief executive officer. The employment contract contained a restriction: After his employment ended, Owen was not allowed to solicit the LLC’s clients for a period of three years.

About four years later, the company fired Owen. Before the three-year poaching period expired, Owens formed a competing business and sent emails to several of the LLC’s clients. He informed them that he had started a new company “with a bigger perspective, more resources and a much stronger team.” The team included two former employees of the LLC. Owen concluded his letter with this note, “I thank everyone who is supporting us in this transition and I look forward to the remarkable opportunities that we have ahead of us with our new company.”

Shortly thereafter, one of LLC’s clients invited Owen to bid on a project. In addition, Owen submitted offers to several other clients.

The LLC sued, among other things, for alleged breach of contract and sought injunctive relief to prevent Owen from soliciting clients. The court issued the injunction, which ultimately stood until the end of the three-year blocking period. The court also awarded the LLC $596,114 in fees and $84,125 in costs.

Non-solicitation is enforceable

The appeals court ruled that the three-year non-solicitation clause in Owen’s employment contract was enforceable.

Owen argued that the seller exception in Section 16601 should not apply. He pointed out that when he transferred his interest to the new LLC, he owned 100 percent of the LLC. Four days later, the investor bought 50 percent of the new LLC. In his view, he merely “consolidated all of his businesses into an LLC through a Contribution Agreement,” and he “did not sell or dispose of any of his business or membership interests” to the investors.

The court rejected this claim. Considering the entire transaction, which took place through multiple agreements entered into over several days, the court found that Owen had “sold” or “otherwise disposed of” all of his interests in his company to the newly formed LLC. The fact that he held an interest in the new LLC didn’t matter.

The court also rejected Owen’s argument that the non-solicitation clause could not be enforced because it was in his employment contract and not in the company purchase agreement. The court found that the employment contract was part of the whole transaction, which was a series of agreements that “must be read together.” The court stated: “[The LLC’s] The ability to enforce non-solicitation is not defeated by having that provision in one contract in a multi-contract joint venture rather than another.”

Court explores meaning of ‘prompt’

The Court of Appeals also found that the communications Owen sent to clients constituted “solicitation” in breach of his agreement.

The court proceeded from the premise that a solicitation does not include a general announcement or advertisement informing the public of new business. Citing a previous case, the court noted that “‘[m]Merely informing customers of the former employer about a job change is not poaching. Nor does a willingness to discuss business at the invitation of another party constitute a solicitation on the part of the invitee. Equity does not prevent a former employee from accepting business from his ex-employer’s clients, even if the circumstances are such that he may be prohibited from doing so should do such business.’”

However, when the communication does more than just announce new business, but also lures customers with a competitive alternative and invites customers to discuss it, the communication can be an invitation.

The court found that Owen’s letter contained elements of the solicitation. “The letter was specifically addressed to his ‘past and potential future clients,'” the court wrote. “He boasted that his new venture was … a superior alternative to [the LLC]with “greater perspective, more resources, and a much stronger team,” including two former ones [LLC] Employees who combined [brought] over 100 years of experience in the HVAC industry.'” The court found that “[t]A direct call for future work, the letter was sent directly to selected representatives of [the LLC’s] Corporate banking. The letter thus constituted a legal request.”

Accordingly, the Court of Appeal affirmed the decision of the Court of First Instance. In addition, the appeals court found that the trial court awarded the buyers $596,114 in attorneys’ fees and $84,125 in costs.

The central theses

Generally, non-compete and non-solicitation clauses are not enforceable in California courts. Employers may want to review non-disclosure agreements, non-disclosure agreements, and non-solicitation agreements to determine their viability in California.

A narrow exception applies to the seller of a company who sells his entire share. Courts can look at the entirety of a transaction to determine if this exception applies. An employment contract that contains a restrictive agreement may be enforceable if it is part of a global transaction involving the sale of a business. Companies should be careful to structure corporate acquisitions in a way that allows non-solicitation in California to be enforceable.

Where the narrow exception applies, general announcements or advertisements are unlikely to constitute a solicitation. Language that constitutes a direct call for future work in a communication sent directly to select clients may violate a non-solicitation agreement.

© 2022, Ogletree, Deakins, Nash, Smoak & Stewart, PC, All rights reserved.National Law Review, Volume XII, Number 98

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