Ninth Circuit Inquiry on Non-Competes Could Have Huge Implications
August 8 2019
The Ninth Circuit recently asked the California Supreme Court to provide it with guidance concerning certain types of non-compete provisions that could have huge ramifications for California’s business environment. In essence, the Ninth Circuit asked the California Supreme Court whether section 16600 of the California Business and Professions Code bars agreements between businesses that place a restriction on one business from doing business with another. Depending on how the California Supreme Court answers the inquiry, the result could have a massive impact on a wide range of agreements in California such as franchise agreements, manufacturer/distributor agreements, joint ventures, etc.
When cases are brought in federal court concerning state law, the federal court is often required to look to case law from that state to determine how a state court would rule on the law at issue. If there is insufficient guidance from the state courts on a particular issue, then a federal court, such as the Ninth Circuit Court of Appeals can “certify” an issue to that state’s highest court in order to obtain guidance on how it should rule in the particular matter before it. This is the procedural mechanism by which the Ninth Circuit in the case, Ixchel Pharma, LLC v. Biogen, Inc., recently certified the following issue to the California Supreme 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?”
In other words, does the prohibition set forth in section 16600 on non-competes apply beyond the employer-employee context?
By way of background, Ixchel Pharma is a biotechnology company that is involved in the development of drugs used to treat mitochondrial disease. It was working on a drug containing dimethyl fumarate that it hoped could be used to treat Friedreich’s Ataxia, a rare neurological disease.
In January 2016, to further its development efforts, Ixchel entered into a Collaboration Agreement with a Danish company, Forward Pharma. Under the terms of that agreement, the two companies would work together to develop a new dimethyl fumarate drug and the agreement set forth the parties’ respective obligations with regard to clinical trials, manufacturing and marketing the new pharmaceutical drug. Ixchel was to receive a percentage royalty based on the sale of the new drug when it was approved for market. The Collaboration Agreement also allowed Forward to terminate the agreement upon 60 days written notice.
Later in 2016, Forward began negotiations with a different pharmaceutical company, Biogen, to settle a dispute between the two companies. Ixchel alleges that during those negotiations, Forward improperly shared a copy of the Collaboration Agreement with Biogen and Biogen concluded that the development of the new drug could harm its own sales. As part of the negotiations, Biogen is alleged to have requested Forward terminate its Collaboration Agreement with Ixchel. In January 2017, Forward and Biogen entered into an agreement by which Biogen agreed to pay Forward $1.25 billion and Forward agreed to terminate its relationship with Ixchel. Section 2.13 of the agreement between Forward and Biogen provided, “Ixchel. Each of the Additional Parties and [Forward] shall, and shall cause of each of its respective controlled Affiliates to, terminate any and all existing, and not enter into any new, Contracts or obligations to Ixchel Pharma, LLC … to the extent related to the development of any of the Additional parties, [Forward] or any of their respective controlled Affiliates of any pharmaceutical product having dimethyl fumarate as an [active pharmaceutical ingredient] for the treatment of a human for any indication, including Friedreich’s Ataxia.” After entering into the agreement, Forward sent written notice to Ixchel that it was terminating the Collaboration Agreement.
Ixchel filed suit in federal court against Biogen claiming that it was liable for tortious interference with contract, intentional/negligent interference with prospective economic advantage and violations of California’s unfair competition law. The district court dismissed the complaint with leave to amend, concluding that Ixchel had failed to state a claim because it had not alleged that Forward had engaged in any independently wrongful act in entering into its agreement with Biogen.
Ixchel filed an amended complaint to allege that Forward, by entering into the agreement with Biogen that contained section 2.13, violated section 16600 of the Business and Professions Code and its prohibitions on non-competes. Once again, the district court disagreed with Ixchel and dismissed the claims finding that Ixchel had again failed to allege an independent wrongful act. Ixchel appealed the decision to the Ninth Circuit which, after briefing, decided to certify the above question to the California Supreme Court.
The Ninth Circuit’s certification request began by recognizing that historically California allowed contractual restrains on a profession or trade “as long as they were reasonably imposed.” However, this view changed in 1872 when California, in support of its strong public policy favoring open competition, adopted the law that became section 16600 of the Business and Professions Code, which provided a broad right for individuals “to pursue any lawful employment and enterprise of their choice.” In 2008, the California Supreme Court, in Edwards v. Arthur Andersen, LLP, recognized that under this broad right, “an employer cannot by contract restrain a former employee from engaging in his or her profession, trade or business, unless the agreement falls within one of the exceptions to the rule” [i.e., concerning the sale of a business, partnership or LLC interest]. The Ninth Circuit held that in its Edwards decision, the California Supreme Court was rejecting prior Ninth Circuit case law that had recognized a “narrow restraint” exception to section 16600, which allowed for non-compete provisions if they barred an individual “from pursuing only a small or limited part of the business trade or profession.”
In 2015, the Ninth Circuit decided Golden v. California Emergency Physical Medical Group, which involved the incorporation of a provision into a settlement agreement between a terminated employee and his former employer that operated in essence as a non-compete. In holding that that provision could violate section 16600, the Ninth Circuit recognized that “because the California Supreme Court `has articulated a broad understanding of what constitutes a void contract under section 16000,’ we concluded that the prohibition imposed by section 16600 extended to all `contractual restraints on professional practice’ between employers and employees.”
The Ninth Circuit continued by recognizing that neither it nor the California Supreme Court had decided an issue involving whether section16600 extends to agreements beyond the employee/employer relationship such as to contractual restraints on business operations. Ixchel argued to the Ninth Circuit that nothing in the plain language of section 16600 prevented it from being applied to such agreements. The Ninth Circuit recognized that section 16600 referenced the term “anyone” which was not defined. However, it could be interpreted to mean “any person,” which was well settled under numerous other California laws that “person” could include a corporation, partnership or other business entity.
Ixchel urged the Ninth Circuit to read section 16600 broadly in light of the Edwards decision “to bar any contracts restraining a business from engaging in a lawful business.” Because section 2.13 of the agreement between Forward and Biogen prevented Forward from entering into a business relationship with Ixchel, it claimed it violated section 16600 of the Business and Professions Code.
Biogen, on the other hand, urged the Ninth Circuit to limit the applicability of section 16600 to the employment context. First, it argued that applying section 16600 more broadly “would be contrary to the rule of reason in the federal antitrust context and invalidate ordinary commercial restrictions in contracts.” For instance, adopting such a broad reading of section 16600 would place in jeopardy exclusive dealing agreements and agreements between manufacturers and its dealers limiting the geographic location in which the dealers could sell the manufacturer’s products. Other legal commentators have noted that a broad interpretation of section 16600 could put at risk “every joint venture, lease, distribution agreement, license agreement and many other widely used business agreements.” (Citing, Perry & Howell, “A Tale of Two Statutes: Cipro, Edwards, and the Rule of Reason,” 24 Competition: J. Anti., UCL & Privacy Sect. St. B. Cal. 21-22 (2015).) Biogen argued that California’s legislature could not have intended such a drastic impact that would result from such a broad application of section 16600.
As a result of these competing arguments, and in light of the fact that there had been no prior California Supreme Court guidance on this issue, the Ninth Circuit certified this very important issue to the California Supreme Court before it would take up the merits of Ixchel’s appeal. The California Supreme Court could always decline to review the certified question presented, but it is unlikely to do so in this case given the potential stakes at issue. We expect the California Supreme Court to act on this issue by mid-2020. If the California Supreme Court accepts certification and agrees with Ixchel as to a broad reading of section 16600 beyond the employer/employee context, all companies doing business in California should consult with legal counsel about reviewing and/or drafting agreements to ensure compliance with this potentially new reading of section 16600.