In a recent decision, a California Second District Appellate Court upheld a trial court “issue sanction,” which effectively enforced, albeit temporarily, a five-year, unlimited geographic scope employee noncompete agreement against the defendant former employee. NewLife Sciences v. Weinstock, — Cal.Rptr.3rd –, No. B223212, 2011 WL 2739653 (July 15, 2011). While such noncompete agreements are normally void and unenforceable under California’s well-known statutory bar against employee noncompetes (see Cal. Bus. & Prof. Code § 16600), the court stated that the temporary enforcement of the employee noncompete was a permissible issue sanction against the former employee, who time and time again refused to appear for depositions or answer hundreds of deposition questions. The court did not appear to rule on plaintiff’s argument that the noncompete fell within the sale-of-business exception under Section 16601, even though the court acknowledged that argument in its opinion. Section 16601 makes enforceable a reasonable non-competition clause executed by 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 . . . .” Section 16601 protects the purchaser of a business against competition from the seller.
Some may argue, and the dissent so stated, that the decision may conflict with California’s settled public policy against employee noncompetes. Nevertheless, the decision is an example that courts sometimes find ways to enforce noncompetes if there is strong evidence of the former employees’ untoward conduct, particularly discovery abuses.
The Parties and the TMR Device
Plaintiff NewLife Sciences (“NLS”) purchased from defendant Weinstock and his company the patent rights to a Therapeutic Magnetic Resonance Device (“TMR”), which was developed for pain management therapy, and all the other assets of the company. As part of the transaction, NLS hired Weinstock (who was not a doctor) as its chief science and technology officer and board chairman for five years. Weinstock’s employment contract provided, in relevant part, that he (i) could be terminated at any time for “fraudulent or unlawful conduct,” (ii) could not compete with NLS while working there, and, (iii) for five years after his employment, could not compete “directly or indirectly with any activity now or in the future engaged in by NLS.” The post-employment noncompete contained no geographic limitation.
NLS terminated Weinstock in December 2007 for administering TMR services outside of a physician’s presence, in violation of California law, FDA rules, and NLS policy. NLS demanded that Weinstock return to NLS all of its property, including the patented TMR devices. Weinstock did not do so. He continued marketing the devices, and administering treatments.
NLS’s Lawsuit and the Trial Court’s Ruling
NLS sued Weinstock, claiming breach of the noncompete, and other tortious conduct directed at NLS. NLS produced evidence that Weinstock was smearing NLS in the marketplace, appeared on a television show pawning himself off as the owner of the TMR patent, and soliciting customers and investors for the TMR operations. The trial court denied Weinstock’s early motion to strike, which was based on the Section 16600 noncompete bar. Weinstock subsequently refused to appear for his deposition, answer relevant deposition questions, and produce documents as ordered by the court. Weinstock cited the statutory bar as justification for his refusal to respond to discovery. As punishment for what the trial court called his “arrogant and contemptuous disregard for the orders of this court,” the trial court entered a severe issue sanction against Weinstock, such that the following issues were established for all purposes in the litigation:
1. Weinstock breached his employment contract by competing with NLS while still employed;
2. The noncompete was enforceable;
3. Weinstock breached the noncompete post-employment by using the TMR device without proper physician supervision; and
4. Weinstock’s breach caused NLS damages.
Based on the issue sanctions and NLS’s evidence, the trial court entered a preliminary injunction against Weinstock and his affiliated companies from competing with NLS throughout the litigation, including an injunction against making or marketing the TMR device or something similar, and soliciting new, potential or existing customers for TMR devices. The trial court later entered terminating sanctions against Weinstock, and awarded NLS default judgment against Weinstock. He appealed.
Appellate Court Decision and Dissent
The Appellate Court upheld the trial court’s preliminary injunction and default judgment. The court did not examine the merits of the Weinstock’s Section 16600 or NLS’s 16601 argument. Rather, the court held that the trial court did not abuse its discretion by entering the issue sanction, and later awarding default judgment in favor of NLS and against Weinstock. Defendants’ repeated and willful non-compliance with the trial court’s discovery orders, the Appellate Court held, were sufficient to warrant the court’s sanctions.
The dissent stated that the trial court should not have enforced an illegal noncompete by way of a discovery sanction. The trial court and the Appellate Court majority should not have set aside, in the name of discovery sanctions, California’s strong public policy against employee noncompetes. At a minimum, the dissent stated, the trial court should have held an evidentiary hearing on whether the noncompete fell under the Section 16601 sale-of-business exception.