By Molly Joyce
The Idaho Supreme Court, in the case of T.J.T., Inc. v. Mori, 2011 WL 5966870, No. 37805 (Id. Nov. 30, 2011), recently found that a two-year non-compete agreement executed in connection with the sale of a business was enforceable under California law, despite the fact that the seller also became an employee of the purchasing company as a result of the sale. The Idaho high court also remanded the case for consideration of whether the non-compete agreement’s overbroad geographic restriction could be “blue-penciled” to comply with California law.
The case arose out of a 1997 non-compete agreement between plaintiff, T.J.T., and defendant, Mori, executed in connection with the sale of Mori’s tire and axel recycling business, Leg-It Tire Company, Inc., based in California. The agreement prohibited Mori from operating anywhere within 1,000 miles of any facility owned or operated by T.J.T. or Leg-It for two years following the termination of his employment with T.J.T. Although Mori became an employee of T.J.T. as part of the deal, his employment was governed by a separate employment agreement.
Mori worked for T.J.T. until February 7, 2007. Within weeks of his resignation, Mori began work with a competitor of T.J.T. In June 2007, T.J.T. filed a complaint seeking injunctive relief and a constructive trust based on several claims, including breach of fiduciary duty and breach of contract. The district court denied T.J.T.’s request for injunctive relief and ultimately granted Mori’s motion for summary judgment, finding that the agreement was void under California law. The district court concluded that the agreement was tied to Mori’s employment instead of the sale of his business, and that the durational and geographical scopes of the agreement were too broad.
The Idaho Supreme Court reversed and remanded the district court’s opinion. First, the court held that the non-compete provision was indeed enforceable. The court recognized that, as a general proposition, California has a strong public policy against non-compete agreements. An exception, however, to this prohibition is in the case of the sale of the goodwill of a business, citing California Business and Professions Code § 16601, the purpose of which “is to permit the purchaser of a business to protect himself or itself against competition from the seller which competition would have the effect of reducing the value of the property right that was acquired.” Citing Monogram Industries, Inc. v. SAR Industries, Inc., 64 Cal. App. 3d 692, 701, 134 Cal. Rptr 714, 720 (Ct. App. 1976).
Mori argued that the non-compete provision was clearly tied to his employment with T.J.T., and therefore unenforceable. The Idaho Supreme Court disagreed, noting that “California courts have held that a non-competition agreement can be incidentally linked to the seller’s employment agreement with the buying business without offending section 16600 [which prohibits non-compete agreements generally].” Even though Mori’s non-compete agreement referred to Mori’s employment with T.J.T. to determine its duration and enforceability, the court found that such an “incidental” link does not necessarily mean the provision is unenforceable. Instead, the court reasoned that Mori’s employment only came about as part of the larger transaction — the sale of the business to a competitor — and was therefore enforceable.
The Idaho Supreme Court also found that non-compete provision’s duration, which was to last for a period “ending two (2) years following Seller’s termination of employment with the Company for any reason,” was not unreasonable. Mori argued that the non-compete was not enforceable beyond six years (his term of employment, which was four years, plus two years). Yet, the court found that because the language of the non-compete agreement was not tied to the employment agreement, it existed independently of the employment agreement and operated pursuant to its own plain terms. Again relying on the language of California Business and Professions Code §16601, which provides that a seller may agree to refrain from competing so long as the buyer carries on a like business, the court found that the agreement was not unreasonable because T.J.T. continued to operate in the same line of business that Mori’s former business (Leg-It) did at the time of the alleged breach.
Finally, the Supreme Court remanded the case to the district court for consideration of whether geographical component of the non-compete, which prohibited Mori from working anywhere within 1,000 miles of any facility owned or operated by T.J.T. could be judicially narrowed, or “blue-penciled,” to comply with California law. The court recognized that the geographical restriction was indeed overbroad under California law as written, but queried whether the provision could be narrowed. The court reasoned that courts construing California agreements have the authority to narrow otherwise enforceable provisions pursuant to the portion of Section 16600 of the California Business and Professions Code that provides that “[e]xcept as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” The agreement at issue also contained a “Reformation” clause, giving courts the power to reform the agreement to the extent necessary to be enforceable. The court was careful to note that while California courts refuse to modify the agreements before them, they do have a continuing ability to narrow the scope of an otherwise valid agreement.
The T.J.T. court concluded that the key factor in determining a covenant’s proper geographic scope is the determination of what area is necessary to protect the goodwill of the sold business from competition by the seller. The Idaho Supreme Court refused to narrow the agreement, finding that the parties demonstrated a genuine issue of material fact as to the scope of Leg-It’s business. It nonetheless remanded the case to the district court to determine the question of fact and whether the agreement could be narrowed within a scope that was reasonably necessary to protect the goodwill of the sold business.
Although this case involves an Idaho court construing California law, T.J.T. serves as a reminder that one should not automatically assume that a California non-compete agreement with certain employees (particularly those selling their interest in a business) is always unenforceable – even if the party seeking to enforce the agreement is the employer or former employer of the defendant. Likewise, just because a California non-compete agreement contains an overbroad restriction, that might not render the entire non-compete agreement unenforceable if it can be narrowed in scope by the court.