In August 2020, the California Supreme Court, in response to a request from the U.S. Court of Appeals for the Ninth Circuit to clarify California law in a pending federal case, held that California Business and Professions Code Section 16600 does not render void all restraints of trade in business contracts. Rather, in determining whether a B-to-B contractual restriction violates Section 16600, a rule of reason should apply. Yet the court also made clear that its holding does not overturn or diminish its seminal holding in Edwards v. Arthur Andersen-that non-competition agreements and other restraints of trade in employment agreements, including "narrow restraint" restrictions that penalize but do not necessarily prohibit competition, are invalid unless they fall within the Section 16600 sale of business exception.
At the heart of the case is an otherwise standard drug development collaboration agreement between Ixchel Pharma (Ixchel) and Forward Pharma (Forward) through which Ixchel and Forward sought to jointly develop a drug to treat a neurogenerative disorder. At the same time, Forward was embroiled in a patent dispute with a separate biotech, Biogen, involving Biogen's development of a multiple sclerosis drug containing the active ingredient DMF, the same active ingredient in the Ixchel-Forward drug. Biogen and Forward settled their patent dispute, and in the settlement agreement, Forward agreed not to pursue drug development involving DMF, and to terminate all contracts and other obligations related to such a development, including the Ixchel-Forward collaboration.
The Ixchel-Forward collaboration agreement allowed Forward to terminate the contract "at-will." It did so, resulting in Ixchel's lawsuit against Biogen for tortious interference with the collaboration agreement. On appeal from a federal trial court's dismissal of Ixchel's claims, the Ninth Circuit referred to the California Supreme Court two questions: (1) does a claim for tortious interference with an at-will contract require an underlying wrongful act; and (2) what is the proper legal standard to determine whether Section 16600 renders void and unenforceable a business contract like the Biogen-Forward settlement agreement, by which one business (Forward) is restrained from engaging in lawful trade or business with another (Ixchel).
The supreme court first concluded that Ixchel must plead and establish an underlying wrongful act to pursue a tortious inference of contractual relations claim against Biogen, given the at-will nature of the collaboration agreement. Then, the court held that while Section 16600 applies not only to employment and sale of business contracts but also to commercial business contracts like the collaboration agreement, a different standard should apply when scrutinizing contractual restrictions on trade or business in such contracts and whether they violate Section 16600. Specifically, the court held that a "rule of reason" should be applied, i.e., an assessment of whether a restriction on the ability of a business to engage in trade or business is nevertheless reasonable based on a host of factors, including whether the contractual restriction promotes, rather than harms, competition. The case will now return to federal court, where Ixchel and Biogen will continue to litigate under this standard.
This decision confirms that Section 16600 applies to B-to-B contracts, and provides helpful guidance as to the kinds of restraints on trade or business that could lawfully be installed in a B-to-B contract. The decision also makes clear that such restrictions in the employer/employee relationship context continue to be void and unenforceable under California law (subject to the express statutory exceptions within Section 16600).
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