The Goodwill Exception in Complex Business Sales: Are Non-Solicitation Agreements Enforceable?

Non-solicitation and non-compete agreements are generally unenforceable in California. See California Business & Professions Code Sec. 16600. However, this codified policy of open competition and employee mobility has an important exception, the sale of goodwill exception. See Sec. 16601 of the same Business & Professions Code:

"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 . . . may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business so sold, or that of the business entity, division, or subsidiary has been carried on, so long as the buyer . . . carries on a like business therein."

The underlying reason for this sale of goodwill exception is that a business buyer would not want to pay for something that would immediately be diminished in value by the seller's competition.  In other words, this Sec. 16601 exception aims to protect the buyer's interest in preserving the goodwill of the acquired business. 

The goodwill exception is limited to specific situations - the sale of all ownership interest in a business.  A partial sale will not suffice, not 30%, not 50%, and not even 99%.  However, the 100% ownership interest does not have to be put into one transaction.  In the recent decision Blue Mountain Enterprises, LLC. v. Owen, the California appellate court clarified that the disposition of "all ownership" interest does not have to be memorialized in one agreement and does not have to be placed in a specific type of document (such as Share Purchase Agreement or Merger Agreement). 

The sale of the ownership can be conducted through a series of transactions.  For example, in the Blue Mountain Enterprises case, the sale of the business was made through four interrelated agreements and several entities.  The defendant entered into a joint venture with the buyer of his businesses by creating a new entity, Blue Mountain Enterprises, LLC ("Blue Mountain"), and transferred all his businesses to the new entity.  The defendant had 100% of Blue Mountian and then transferred 50% to the buyer.  In exchange, the buyer paid the money, and Blue Mountain hired the defendant as its CEO.  Not long after, the defendant was terminated for cause, started another company, and sent soliciting emails to Blue Mountain's customers.  Blue Mountain sued him for breach of the non-solicitation agreement.

The court found the non-solicitation agreement enforceable under the goodwill exception, saying that the four agreements were a part of a multi-contract joint venture, and as read together, the defendant did sell his whole ownership interest through the series of agreements. Id. at 17.  

In applying the goodwill exception, the court will look at the sale as a whole even when several different agreements and transactions involve several entities with less than 100% ownership transfers. Nonetheless, to ensure a non-compete or non-solicitation agreement is enforceable, it is better to make it clear and explicit that the seller is selling and the buyer is buying 100% of the business.
EN KOR RUS Employment Law Business Law