Non-Compete Orders and Agreements in a Family Law Action
Business interests are routinely divided in family law actions, but we rarely see non-compete orders or agreements against the bought-out spouse. A non-compete order or agreement protects the value of a business awarded to one spouse, by prohibiting the other spouse from engaging in a similar business.
The court has the legal authority to prohibit a spouse from engaging in any business that competes with the business awarded to the other spouse in a divorce. Parties may also make a non-compete agreement in connection with a divorce settlement. There is a strong public policy favoring a person’s right to pursue any lawful business, trade, or occupation, so a non-compete order or agreement will be deemed void unless the provision is reasonably necessary to protect the value that person receives for his or her interest in the community business. To be valid, the business must have goodwill, and the terms of the non-compete agreement or order must be narrowly tailored.
This article discusses the circumstances in which a family law court may make a non-compete order, the authority of the parties to make a non-compete agreement, and the proper scope of such an order or agreement. Trade secrets will also be addressed.
II. Non-Compete Agreements
A. Agreements Restraining Lawful Work are Generally Void
Any agreement that restrains an individual from engaging in a lawful profession, trade, or business of any kind is void, except as otherwise provided. Cal. Bus. & Prof. Code §§ 16600-16602.5, 20. “California courts have consistently declared [section 16600] an expression of public policy to ensure that every citizen shall retain the right to pursue any lawful employment and enterprise of their choice.” Metro Traffic Control, Inc. v. Shadow Traffic Network, 22 Cal. App. 4th 853, 859 (1994).To be void, the agreement does not have to totally preclude a party from engaging in a profession, trade, or business; any restriction is invalid unless one of the statutory exceptions applies. Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946-947 (2008).
B. Exception for Agreements re Sale or Disposition of Business
Noncompetition clauses are expressly permitted in connection with the sale or disposition of a partnership, limited liability company (LLC), or corporation (Cal. Bus. & Prof. Code § 16601), the dissolution of a partnership or disassociation of a partner from the partnership (§ 16602), or the dissolution of a LLC or the termination of an interest in a LLC (§ 16602.5). If one of these exceptions applies, then the owner of the business interest “may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business so sold … has been carried on, so long as the buyer, or any person deriving title to the goodwill or ownership interest from the buyer, carries on a like business therein.” § 16601.
An agreement by one spouse to transfer an interest in a business entity to the other spouse in connection with a divorce should qualify under the exceptions to section 16600. For example, section 16601 permits any person “who sells the goodwill of a business, or any owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity” to enter into a non-compete agreement. § 16601 (emphasis added). A transfer of a business interest from one spouse to another pursuant to an agreement is a “disposition” of that party’s interest within the meaning of section 16601. Also, treating divorce agreements the same as regular business agreements in this context is consistent with the statutory purpose of section 16601. “The reason for this exception to the general rule against noncompetition covenants is to prevent the seller from depriving the buyer of the full value of its acquisition, including the sold company’s goodwill.” Alliant Ins. Services, Inc. v. Gaddy, 159 Cal. App. 4th 1292, 1300 (2008).
Therefore, parties to a divorce may enter into a non-compete agreement, and that agreement will be enforced, provided that the agreement meets the other requirements of sections 16601 to 16602.5. Those requirements are discussed below.
C. Requirements for Valid Non-Compete Agreements
A non-compete agreement made in connection with the sale, disposition, or dissolution of an ownership interest in a business entity must satisfy the following requirements to be valid:
1. Restricted to Similar Business
The agreement may only restrict the seller from carrying on a “similar business” to the one sold. § 16601. The California Legislature did not intend to permit “restraints upon all business transactions of whatever character, regardless of their noncompetitive effect, their insubstantial nature, or their infrequent occurrence. Instead, [the California Supreme Court has] concluded that in using the words ‘carry on a similar business,’ the Legislature had in mind the direct or indirect transaction or solicitation of substantial business activities in competition with the covenantee, rather than the occurrence of isolated, occasional transactions not substantially affecting the covenantee’s competition position.” Swenson v. File, 3 Cal. 3d 389, 397 (1970) (citation omitted). The Court in Swenson added: “Ordinarily, a single, isolated transaction does not constitute ‘carrying on business’ under statutes using that or similar terminology.” Id. at p. 397, fn.5 (citation omitted).
2. Specified Geographic
The agreement must be limited to “a specified geographic area in which the business so sold … has been carried on.” Id. at p. 397. “The geographic scope of a noncompetition covenant must be limited to the area where the sold company carried on business because ‘[o]therwise, a seller could be barred from engaging in its business in places where it poses little threat of undercutting the company it sold to the buyer.’” Alliant, 159 Cal. App. 4th at 1301 (citation omitted). “[T]he area where a business is ‘carried on’ [within the meaning of section 16601] is not limited to the locations of its buildings, plants and warehouses, nor the area in which it actually made sales. The territorial limits are coextensive with the entire area in which the parties conducted all phases of their business including production, promotional and marketing activities as well as sales.” Monogram Indus., Inc. v. Sar Indus., Inc., 64 Cal. App. 3d 692, 702 (1976).
3. Duration Limited to While Buyer is Carrying on Similar Business
The agreement may only last as “long as the buyer, or any person deriving title to the goodwill or ownership interest from the buyer, carries on a like business [within the specified geographic area].” Cal. Bus. & Prof. Code § 16601.
4. Business Must Have Goodwill Which Was Sold
The business must have goodwill at the time of the sale, disposition, or termination of the business interest, and “there must be a clear indication that in the sales transaction, the parties valued or considered goodwill as a component of the sales price.” Hill Medical Corp. v. Wycoff, 86 Cal. App. 4th 895, 900 (2001). The value protected by a non-compete agreement is the goodwill of the business. “In order to restrain the seller’s profession, trade, or business, there must be a clear indication that in the sales transaction, the parties valued or considered goodwill as a component of the sales price, and thus the … purchasers were entitled to protect themselves from ‘competition from the seller which competition would have the effect of reducing the value of the property right that was acquired.’” Id. at 903.
III. Non-Compete Orders
The next question is whether a family law court may enter a non-compete order against a party, over that party’s objection, when the court awards a business interest to one party in a marital dissolution. The answer is yes, it can. See Marriage of Greaux & Mermin, 223 Cal. App. 4th 1242 (2014).
In Greaux & Mermin, the court awarded a community business to the husband and ordered the wife not to compete with that business. See id. The Court of Appeal in Greaux & Mermin held that the trial court had the legal authority to make the non-compete order, but reversed and remanded the case because the length and geographic scope of the non-compete order were overly broad. Id. The Court of Appeal held that Business and Professions Code section 16600 does not prohibit the issuance of a non-compete order. Id. The court stated:
Family law courts have broad statutory powers to make any orders the court considers necessary to achieve a fair and equal division of the community property, including a do-not-compete order. If section 16600 were interpreted to prohibit such family law orders, the proscription would unduly restrict the court’s inherent equitable powers and inhibit its ability to achieve a fair division of property. The order entered here was a ‘logical way to preserve the integrity of [the court’s] award of SBSC to [husband] and the value of the business,’ and was supported by ample evidence….
Countervailing the public policy in favor of free competition is the state’s ‘”paramount interest”’ in the fair and equal distribution of marital property upon the dissolution of a marriage. (In re Marriage of Potter (1986) 179 Cal.App.3d 73, 81 [224 Cal.Rptr. 312].) Family courts have therefore been granted broad statutory powers to accomplish a just and equal division of marital property (Fam. Code, §§ 2550, 2553) and possess “broad discretion to determine the manner in which community property is awarded in order to accomplish an equal allocation. [Citation.]” (In re Marriage of Andresen (1994) 28 Cal.App.4th 873, 880.) “This task constitutes a nondelegable judicial function [citation] which must be based upon substantial evidence [citation].” (Ibid.) Pursuant to statute, the court may make “any orders the court considers necessary” to achieve the statutory mandate. (Fam. Code, § 2553.) …
It therefore follows that, if an ongoing marital business is being awarded to one spouse, and if the value of that business includes goodwill, a family court should have the power, pursuant to Family Code section 2553, to issue a noncompetition order so that the value of that asset is preserved, just as a noncompetition clause in a business purchase and sale agreement is designed to protect the value of the asset purchased.
Greaux & Mermin, 223 Cal. App. 4th at 1249-1250.
Even though a non-compete order is not precluded by section 16600, a court must still comply with the same requirements that apply to non-compete agreements when issuing a non-compete order.
A. Scope of Order in Greaux & Mermin
The trial court in Greaux & Mermin ordered that “[Wife] shall refrain from further conduct intended or likely to damage either business in any way and shall be subject to a five-year non-competition order.” Id. at 1247. It appears that the trial court also made the following orders at the husband’s request:
[Wife is] restrained and enjoined from:
(1) contacting or communicating with ‘any person or entity in the SBSC/Batiste infrastructure’ including its growers, distillers, shippers, bottlers, distributors, attorneys, employees, consultants, customers ‘or other persons doing business with SBSC’;
(2) holding herself out as a representative of SBSC or of the brand Batiste;
(3) holding herself out as having any connection or involvement with SBSC or Batiste rum; and
(4) entering the premises of SBSC or dealing with the books, bank accounts and records of SBSC….
[Also, wife is] ‘restrained and enjoined from competing with [husband] or SBSC for a period [of] five years from entry of judgment herein. She shall not … [set] up a company of her own or with other investors, or persons or entities engaged in the production, bottling, marketing or selling [of] Rhum Agricole or rum of any kind, wherever produced or grown. Further, [Wife] shall not consult with any person or entity that is in competition with or could be in competition with SBSC’s rum product or who proposes to offer a competing product. She shall not work for a competitive Rhum Agricole product or other rum product during the five year period.’
Id. at 1247-1248.
The Court of Appeal in Greaux & Mermin held that the “the scope of prohibited activities and the length of the prohibition [must] be based on findings supported by substantial evidence that they are reasonably necessary to protect the value of the asset awarded in the dissolution.” Id. at 1255. “Here, wife was restrained from working in a rhum agricole business or other rum product business, or any other business that ‘could be in competition with SBSC’s rum product’ for a period of five years, without geographical limitation.” Id. This was an abuse of discretion because the “statement of decision, however, contains nothing about the geographic market of SBSC at the time of the dissolution, nor does it contain any findings to support the unlimited geographic reach of the order.” Id.
B. Problem with Arguing that there is No Goodwill
Another issue with the non-compete order in Greaux & Mermin was the potential lack of goodwill of the community business. The Court of Appeal observed:
According to the trial court’s statement of decision, there was undisputed evidence that SBSC had no value attributable to goodwill, but did have an ‘in-place value’ (based on existing contracts) of $49,000. Because the issue is not before us, we express no opinion as to whether a noncompetition order can be imposed in the absence of goodwill if there is some other evidence demonstrating a need to protect the value of the asset assigned to one of the parties by the issuance of a noncompetition order. It is clear, however, that a court must be able to point to evidence that supports the necessity of the order to protect the value of the business ‘as a going concern.’
Id. at 1255-1256 (citations omitted).
So, care needs to be taken when arguing that a business has no goodwill if the client wants that business awarded to him or her, with a non-compete order against the other party. If the court agrees that the business has no goodwill, then there is no legal authority to make a non-compete order.
C. Evidence of Interference
The law does not require evidence of interference with the business, or a showing that a party intends to compete, as a prerequisite to making a non-compete order. Still, it helps. In Greaux & Mermin, the trial court found:
The parties … had personal conflicts that took their ‘inevitable toll on the business itself … [e]ven during the company’s earliest, most formative days.’ … [W]ife filed concurrent actions against SAF and SBSC, and lawsuits against key SBSC resource contacts. Wife also disrupted the business operations of SBSC by withdrawing operating capital on two occasions and making statements to employees ‘portending the demise of the businesses.’
In the lawsuits, wife sought to dissolve SAF and SBSC, assailed the personal integrity of individuals associated with SBSC, and ‘substantially compromise[ed] the company’s ability to attract essential capital.’ She alleged that SBSC was `insolvent or in imminent danger of becoming insolvent,’ and accused product suppliers, corporate officers and corporate counsel of fraud and conspiracy. ‘Although she ultimately dismissed all of those actions, considerable harm had already been done.’…
Further, husband had ‘demonstrated the will and ability to [run the business] under extremely adverse circumstances,’ while wife had shown ‘a willingness to sacrifice the interests of SBSC for what appeared to have been little more than spiteful retribution.’
Id. at 1246-1247.
The Greaux & Mermin decision does not discuss whether the requirements for a preliminary injunction must be satisfied when a court makes a non-compete order. It appears that those requirements must be followed, since a non-compete order is a form of an injunction. See Cal. Civ. Proc. Code § 525.
E. Compare Trade Secrets
“The right of free competition is also constrained by California’s Uniform Trade Secrets Act, which prohibits the use of another’s trade secrets to compete even where the parties have entered into an invalid noncompete agreement under section 16600.” Greaux & Mermin, 223 Cal. App. 4th at 1249, fn.3 (citing Cal. Civ. Code § 3426 et seq.; Morlife, Inc. v. Perry, 56 Cal. App. 4th 1514, 1520 (1997); Scott v. Snelling and Snelling, Inc. 732 F. Supp. 1034, 1042 (N.D. Cal. 1990)).
The Court of Appeal in Greaux & Mermin stated that “the value of a marital asset’s trade secrets may also be an appropriate matter for the family court to consider.” Id. at 1252. Trade secrets, such as customer lists, may be protected by court order even without a non-compete order.
The parties may enter into an agreement prohibiting the other party from competing with a community business that is awarded to one party, provided that the scope of the order is reasonable and the business has goodwill. When the parties cannot agree, the court may make such an order over the objection of the other party. These orders and agreements should be considered whenever the client is concerned that the bought-out spouse will compete with the community business after division. ■