In a recent decision, Ixchel Pharma, LLC v. Biogen, Inc.,[1] the Supreme Court of California opened the door for some restrictive covenants between commercial enterprises, but it left alone California law generally prohibiting post-employment restrictive covenants with employees.

Snapshot:

Ixchel presented two questions about the bounds of legitimate business competition under California tort and antitrust law:

1. Is a plaintiff required to plead an independently wrongful act in order to state a claim for tortious interference with a contract that is terminable “at will?”

2. What is the proper standard to determine whether California Business and Professions Code section 16600 voids a contract by which a business is restrained from engaging in a lawful trade or business with another business?

The Supreme Court of California held that:

1. For one company to tortiously interfere with an at-will contract between two other companies, the company’s act must be independently wrongful.

2. The proper standard to determine whether contractual restraints on business dealings are void, under Business and Professions Code section 1660, is the Rule of Reason.

“An act is independently wrongful, as an element of tortious interference with prospective economic advantage, if it is unlawful, that is, if it is proscribed by some constitutional, statutory, regulatory, common law, or other determinable legal standard.”

“The Rule of Reason … asks whether an agreement harms competition more than it helps by considering the facts peculiar to the business in which the restraint is applied, the nature of the restraint and its effects, and the history of the restraint and the reasons for its adoption.”

Context:

Two pharmaceutical companies, Forward Pharma and Biogen, Inc., entered into a settlement agreement. As part of the agreement, Forward agreed to implement its at-will contractual right to terminate a drug development agreement with a third pharmaceutical company, Ixchel Pharma.

As a result, Ixchel sued Biogen in California federal court. Ixchel asserted that Biogen tortiously interfered with Ixchel’s and Forward’s contractual relationship, and that Biogen’s agreement with Forward was an unenforceable noncompetition agreement under California Business and Professions Code section 16600. The 9th Circuit Court of Appeals certified these questions to the Supreme Court of California.

A claim for tortious interference with contractual relations includes intentional acts designed to induce a breach or disruption of a contractual relationship and actual breach or disruption of the contractual relationship. But the Ixchel court made clear that such a claim will not stand where the contract is freely terminable at the will of the parties to it. Instead, the court disapproved other, previous decisions and concluded that the correct claim is tortious interference with prospective economic advantage, which requires independent wrongfulness. An act is independently wrongful, as an element of this tort, “… if it is unlawful, that is, if it is proscribed by some constitutional, statutory, regulatory, common law, or other determinable legal standard.”[2] The court explained that the purpose of this requirement is to “… balance between providing a remedy for predatory economic behavior and keeping legitimate business competition outside litigative bounds.’”[3]

With that foundation laid, the court addressed whether the Forward-Biogen settlement agreement, which called for termination of the Ixchel-Biogen at-will contract, and its implementation were independently wrongful restraints on competition under Section 16600. The court instructed that determination hinged on the Rule of Reason, which “asks whether an agreement harms competition more than it helps by considering the facts peculiar to the business in which the restraint is applied, the nature of the restraint and its effects, and the history of the restraint and the reasons for its adoption.”[4]

The court reasoned that “in certain circumstances, contractual limitations on the freedom to engage in commercial dealings can promote competition.”[5] It observed, “[b]usinesses engaged in commerce routinely employ legitimate partnership and exclusive dealing arrangements, which limit the parties’ freedom to engage in commerce with third parties. Such arrangements can help businesses leverage complementary capabilities, ensure stability in supply or demand, and protect their research, development, and marketing efforts from being exploited by contractual partners.”[6] The court noted further, “[t]hese arrangements can have procompetitive effects since they ‘enable long-term planning on the basis of known costs,’ ‘give protection against price fluctuations, and—of particular advantage to a newcomer to the field to whom it is important to know what capital expenditures are justified—offer the possibility of a predictable market.’”[7] Lastly, the court explained, “[e]xclusive dealing arrangements also ‘may provide an incentive for the marketing of new products and a guarantee of quality-control distribution.’”[8]

Applying the Rule of Reason, the court found that the Forward-Biogen settlement agreement and its implementation were not a violation of 16600 and therefore not independently wrongful to support a claim for tortious interference with prospective economic advantage.

Take Aways:

• Ixchel is significant because it opens the door for some restrictive covenants between commercial enterprises in California, but it does not create an exception to California law generally prohibiting post-employment noncompetition covenants with employees.

• California’s prohibition on restraints of trade is not limited to the employment context.

• For one company to tortiously interfere with an at-will contract between two other companies, the company’s act must be independently wrongful, in addition to the other elements of a tortious interference claim.

The proper standard to determine whether contractual restraints on business dealings are void, under Business and Professions Code section 16600, is the Rule of Reason. Agreements familiar in business, such as exclusive dealing agreements, franchisee requirements, and supply contracts, will not fail under section 16600 unless they fail Rule of Reason analysis.

[1] Ixchel Pharma, LLC v. Biogen, Inc., 9 Cal. 5th 1130, 470 P.3d 571 (2020).

[2] Id. at 1142, 576 (internal citations omitted).

[3] Id. at 1146, 579.

[4] Id. at 1150, 581.

[5] Id. at 1160, 589.

[6] Id. at 1161, 589.

[7] Id. (internal citations omitted).

[8] Id. (internal citations omitted).