California Supreme Court To Decide Whether California’s Ban On Non-Competes Extends to Contracts Between Businesses

Imagine you are a partner in a medical radiology group that has an exclusive contract with a hospital that provides radiological diagnostic services to the hospital’s patients, and that revenues derived from this exclusive contractual relationship comprise a large percentage of your annual income.  Now, imagine that a large third-party radiology company seeks to build out a specialized oncological radiology department at this hospital through a joint venture, and as part of its negotiations, demands that the hospital terminate its exclusive contract with your radiology group.  Since a state-of-the-art oncological radiology department will increase the hospital’s revenues exponentially, the hospital agrees, enters into the joint venture with the third-party radiology company, and terminates its contract with your medical group consistent with the termination provisions set forth in your contract, causing substantial financial damage to you and your partners.  To obtain compensation for your financial loss, you intend to file a lawsuit against the third-party radiology company for intentional interference with your exclusive contract.  However, a pending case before the California Supreme Court may determine whether such interference is permissible under California law.

California Business and Professions Code, Section 16600 states that “[e]very contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.”  Pursuant to this statute, California courts have struck down a number of restrictive covenants in contracts with employees in California, including non-compete provisions, customer non-solicit provisions, and certain employee non-solicit provisions.  The Ninth Circuit now wants to know whether the statute should apply outside of the employment context to an agreement between two businesses.

The Ninth Circuit has certified questions to the California Supreme Court in Ixchel Pharma v. Biogen seeking guidance as to: 1) whether section 16600 of the California Business and Professions Code extends to contracts between businesses; and 2) whether pleading an independent wrongful act is required to state a claim for intentional interference with a contract outside the at-will employment context. The California Supreme Court accepted the Ninth Circuit’s inquiry and the Supreme Court will likely rule in the summer or fall of 2020. The California Supreme Court’s ruling could have major implications for business litigation going forward.

Ixchel Pharma and Forward Pharma are both biotech ventures engaged in the business of developing pharmaceutical drugs. Ixchel and Forward entered into a collaboration agreement in January 2016 to develop a new drug to treat a neurological disease.

Forward and Biogen, another biotech company, began negotiating an intellectual property dispute in 2016 after Forward and Ixchel entered into their collaboration agreement. The intellectual property dispute had no relationship to the new drug being pursued under the collaboration agreement between Ixchel and Forward, but Biogen discovered during its negotiations with Forward that the new drug being developed between Ixchel and Forward would be competing with a new drug under development by Biogen.  Accordingly, the settlement negotiations between Forward and Biogen resulted in a settlement agreement in January 2017, wherein Forward agreed to stop working with Ixchel to develop their experimental drug pursuant to a non-compete provision in the Forward/Biogen settlement agreement. Forward then terminated its collaboration agreement with Ixchel and ceased all work on the new drug.

Ixchel subsequently sued Biogen for: (1) tortious interference with a contract; (2) intentional and/or negligent interference with prospective economic advantage; and (3) violations of California’s unfair competition law which prohibits “any unlawful, unfair or fraudulent business act or practice,” Cal. Bus. & Prof. Code § 17200.  Ixchel alleged that Forward gave Biogen a copy of their collaboration agreement without Ixchel’s consent, that Biogen deemed Ixchel’s development work on the new drug a threat to Biogen’s own drug, and that Biogen asked Forward to cut off ties with Ixchel as settlement in their intellectual property dispute.

The district court dismissed Ixchel’s complaint for failing to state a claim for intentional interference with prospective economic advantage and tortious interference with a contract, reasoning that Ixchel failed to plead that Forward engaged in an independent wrongful act. The district court concluded that the collaboration agreement was an at-will contract, requiring Ixchel to plead a wrongful act. The UCL claim also failed because the complaint failed to allege an actionable unlawful business practice.

Ixchel subsequently amended its complaint to allege a violation of section 16600 of the California Business and Professions Code based on Biogen’s settlement agreement with Forward, which wrongfully restrained Forward from engaging in lawful business with Ixchel.  The district court dismissed the amended complaint on the basis that section 16600 barred non-compete agreements between employer and employee and did not apply to agreements outside of the employment context such as the Forward-Biogen agreement.

Neither the Ninth Circuit nor the California Supreme Court has addressed whether section 16600 extends beyond the employment setting to contractual restraints between businesses. The terms of section 16600 state it applies to contracts restraining “anyone” from engaging in lawful business of any kind.  However, the term “anyone” is not defined.

Under California law, a claim for intentional interference with contractual relations in the context of an at-will employment contract requires the claimant to prove an independently wrongful act.  Reeves v. Hanlon (2004) 33 Cal. 4th 1140. However, the California Supreme Court has not addressed whether Reeves applies outside the at-will employment context.

A broadened interpretation would expand section 16600 to bar contracts restraining a business from engaging in lawful business, potentially invalidating contracts like the Forward-Biogen agreement. The expansion may extend to all contracts, including those dealing with joint ventures, leases, distribution agreements, license agreements, and other widely used business agreements that might fall under the purview of a newly broadened section 16600.

Expanding the independent wrong requirement to at-will contracts beyond the employment context would require aggrieved plaintiffs to plead an independently wrongful act to prove an intentional interference with contract claim.