There are limited exceptions to California’s general prohibition of post-termination non-competition agreements. One such exception is the sale of business exception found in California Business & Professions Code § 16601. This exception allows a buyer to enforce non-compete agreements against a seller if the seller is an “owner of a business entity selling or otherwise disposing of all of his or her ownership interests in the business entity.”
In Blue Mountain Enterprises, LLC v. Owen, 74 Cal. App. 5th 537 (2022), the Court of Appeal found that section 16601 applied to a three year post-termination non-solicitation of customer provision in an employment agreement and upheld the trial court’s decision to enforce the provision against the executive/seller who entered into a joint venture. The court found that section 16601 applied as a matter of law because the defendant “dispos[ed] of all of his … ownership interest” in one transaction agreement while concurrently agreeing under an employment agreement and that both contracts, along with other contracts the parties executed, were drafted to accomplish the parties’ joint venture. Id. at 553. The court also found that the trial court correctly found that the defendant’s letter for his new business constituted a solicitation as a matter of law because the letter went well beyond an announcement by actively encouraging customers to leave and do business with his new company. Id. at 556.
Lastly, the court affirmed the trial court’s award of $600,000 in attorney fees to the plaintiff as the prevailing party on the grounds that plaintiff secured a temporary restraining order, a preliminary injunction, and a permanent injunction against defendant based on the breach of the customer non-solicitation provision. Id. at 560. The court found that the trial court was diligent in arriving at its attorney fee determination and that there was no basis on which to conclude that the trial court’s attorney fee award was “clearly wrong” or that the trial court otherwise abused its discretion in determining the amount of the attorney fee award. Id.
In 1982, Defendant Owen began founding a series of real estate development and construction firms. Id. at 542. After years of developing these firms, Owen entered into a joint venture with Meyer Corporation in 2011, whereby Meyer would provide capital and business expertise to Owen’s firms. Id. At the same time, Owen would continue overseeing and managing the firms. Id. The parties agreed to form a new entity named “Blue Mountain Enterprises, LLC.” Id. Over the course of several months, Owen and Meyer negotiated four contracts to formalize the joint venture: a “Contribution Agreement” by which Owen transferred his ownership interest in all of his businesses, described in the agreements as the “Blue Mountain Entities,” into a newly formed limited liability company (Blue Mountain); a “Membership Interest Purchase Agreement” by which Acolyte, a Meyer subsidiary, acquired a 50 percent ownership interest in Blue Mountain; an “Operating Agreement” for the new company; and an “Employment Agreement” that defined Owen’s future management role in Blue Mountain. Id. at 543.
The joint venture was formalized over a five-day period in April 2011. Id. On April 22, 2011, Blue Mountain was registered as a limited liability company with the Secretary of State. Id. That same day, Owen transferred his ownership interest of the Blue Mountain Entities to Blue Mountain under the Contribution Agreement, receiving a 100 percent membership interest in Blue Mountain in exchange. Id.
On April 26, 2011, Acolyte acquired a 50 percent membership interest in Blue Mountain pursuant to the Membership Interest Purchase Agreement. Id. Acolyte paid $16.5 million in exchange for its interest, $3 million of which went directly to Owen. Id. The residual $13.5 million was retained as working capital for Blue Mountain. Id. The Operating Agreement and the Employment Agreement were also executed on April 26, 2011. Id. Under the Employment Agreement, Owen was hired to serve a five-year term as Blue Mountain’s chief executive officer. Id. The Employment Agreement included a non-solicitation agreement providing that during his employment and for three years following his termination, Owen would not “solicit for himself or any entity the business of a customer of any of the Blue Mountain Entities.” Id.
Four years after Owen became CEO, Blue Mountain fired Owen for cause. Id. In August 2016, Owen formed a new company called Silvermark Construction Services, Inc. (Silvermark). Id. at 544. In June 2017, Owen sent a letter by e-mail to several representatives of Blue Mountain customers, informing them that he had started Silvermark. Id. The letter began with the following salutation: “To my friends; past and potential future clients; and the general public.” Id. The letter declared that Owen had recently sold all his interests in Blue Mountain, and that he had “made the decision to launch a new enterprise with greater perspective, more resources and a much stronger team. Conscious of the environment, evolving technology and the communities we work in, this new venture allows me to incorporate what I have learned from where I have been, while considering where the market and our world is headed.” Id. The letter introduced by name two former Blue Mountain employees who had joined Silvermark, “who combined, bring over 100 years of experience in the HVAC industry.” Id. The letter concluded: “I thank everyone who supports us in this transition and look forward to the remarkable opportunities we have ahead with our new company, Silvermark Construction Services, Inc.” Id.
In 2017, Blue Mountain filed a lawsuit against Owen, alleging that Owen had breached his non-solicitation agreement by sending these letters to Blue Mountain’s customers. Id. at 545. Blue Mountain obtained a TRO and preliminary injunction against Owen. Id. at 546. The amended preliminary injunction enjoined Owen from soliciting or engaging in business with Blue Mountain customers, attempting to interfere in Blue Mountain’s relationships with its customers, and soliciting Blue Mountain employees. Id. Blue Mountain then moved for summary adjudication on Owen’s violation of the customer non-solicitation covenant. Id. at 547.
Trial court’s decision
The trial court granted summary adjudication in favor of Blue Mountain. Id. The trial court determined that the non-solicitation agreement fell within a statutory exception to the general prohibition providing that post-termination non-competition agreements are void. Id. Further, the trial court held that Owen’s letter constituted a solicitation as a matter of law. Id. Owen Appealed. Id. at 548.
Court of Appeal holding
The Court of Appeal affirmed the trial court’s judgment and held that the non-solicitation agreement fell under the sale of business exception. Id. at 553. The appellate court further echoed the trial court in determining that Owen’s letter constituted a solicitation as a matter of law, reasoning that the letter was “a direct appeal for future work and was sent directly to select representatives of Blue Mountain’s corporate customers.” Id. at 556.
(1) The sale of business exception applies even when the transferor holds ownership in the transferee
On appeal, Owen argued that the non-solicitation agreement was unenforceable because he sold only 50 percent of his ownership interests to Acolyte. Id. at 551. Owen pointed out that section 16601 requires a transferor to sell or dispose of all their ownership interests. See id. In Owen’s view, he was merely consolidating his ownership interest into a separate entity. Id. This consolidation, Owen argued, was a transaction separate and apart from Owen’s transactions with Acolyte. See id.
The court disagreed. Although Owen sold only 50 percent of his ownership interests to Acolyte, the plaintiff in this case was Blue Mountain. The court found that Owen’s arguments were contradicted by his own sworn statements and other undisputed evidence in the record. Id. Section 1.2 of the Contribution Agreement provides: “The Contributor [Owen] has agreed to assign, transfer, convey and contribute all of the interests … in the BM Entities to the Company [Blue Mountain] and, in exchange, the Company will issue one-hundred percent (100%) of the membership interest in the Company to the Contributor.” Id. The “BM Entities” consisted of Owen’s full ownership interests in his various companies. Id. The Employment Agreement similarly states that “pursuant to the [Membership Interest] Purchase Agreement, the Executive [defined as Owen] has formed the Company [Blue Mountain], has agreed to contribute to the Company all of the Executive’s ownership interests in the Blue Mountain Entities, and has agreed to sell or cause the Company to issue a total of 50% of the membership interests in the Company to Acolyte.” Id.
Owen’s transactions with Acolyte were beside the point, and it was Owen’s transactions with Blue Mountain that the court would examine under section 16601. The court reasoned that, even though Owen disposed of his ownership interests in a separate agreement which did not cross-reference Owen’s employment agreement containing the non-solicitation provision, both agreements were drafted to accomplish the same joint business venture. See id. at 552. Therefore, the court would construe the agreements together. Id. The court then only needed to determine if section 16601 applied to Owen’s transactions with Blue Mountain.
These transactions did, in fact, fall under the sale of business exception. Id. at 553. Owen owned Blue Mountain at the time he transferred ownership of his firms to Blue Mountain, but this fact is immaterial. The court merely asked: did Owen sell or otherwise dispose of all of his business interests when he conveyed his entire ownership stake in his various companies to Blue Mountain? See id. Yes, he did. Therefore, the sale of business exception applied, and under section 16601, Blue Mountain could enforce the non-solicitation provision as found in its employment agreement with Owen. Id.
(2) Owen’s letters constituted a solicitation as a matter of law
The court then disposed of Owen’s assertion that the letters he sent to Blue Mountain’s customers were not “solicitations” but rather nonactionable advertisements. While there are no cases directly defining “solicitation” in the context of section 16601, the court examined some adjacent cases in addressing this issue. See id. at 554. First, the Supreme Court of California defined “solicit” in Aetna Bldg. Maintenance Co. v. West (1952) 39 Cal.2d 198, stating “‘solicit is defined as: ‘To ask for with earnestness, to make petition to, to endeavor to obtain, to awake or excite to action, to appeal to, or to invite.’”
The court then compared Owen’s letter to a very similar letter at issue in American Credit Indemnity Co. v. Sacks (1989) 213 Cal.App.3d 622. Both letters boasted about a new venture and implied that this new venture would be the superior business alternative. See 74 Cal. App. 5th at 556. Further, both letters were sent to and targeted at potential clients. Id. Owen’s letter boasted that his new venture, Silvermark, was a superior alternative to Blue Mountain, having “greater perspective, more resources and a much stronger team,” including two former Blue Mountain employees “who combined bring over 100 years of experience in the HVAC industry.” Id. The letter was a direct appeal for future work and was sent directly to select representatives of Blue Mountain’s corporate customers. Id. Just as the court in Sacks concluded such letters constituted a solicitation, so the court here concluded that Owen’s letter constituted a solicitation as a matter of law. Id.
(3) Trial Court’s award of fees was appropriate
Owen contended that the trial court erred in determining Blue Mountain to be the prevailing party and awarding attorney fees. Id. at 557. He also asserted that even if the determination was correct, the amount of fees awarded is excessive. Id. The Court of Appeal disagreed.
The court found that while it agreed with Owen that Blue Mountain did not achieve all of its litigation goals, the trial court carefully considered this factor, and it disallowed a significant amount of attorney fees incurred by Blue Mountain where its law firm’s activities did not meaningfully advance the objective of enforcing the non-solicitation covenant. Id. at 559. These disallowed fees activities included filing an amended complaint to allege claims for misappropriation and unfair business practices and conducting discovery on these claims, as well as unsuccessfully opposing several motions filed by Owen and Silvermark. Id. The court found that the trial court carefully considered the procedural record and voluminous contentions by the parties, and determined that Blue Mountain was the prevailing party on its breach of contract cause of action. Id.
The court noted that Blue Mountain sought approximately $2.5 million in attorney fees through judgment, yet the trial court awarded only $523,874, reducing recoverable hours and lowering counsel’s rates to conform to the rates local to Solano County. Id. at 560. The court added $72,240 for fees incurred post-judgment and further found that the record reflects that the trial court was diligent in arriving at its attorney fee determination. Id. The court determined that there was no basis on which to conclude that the trial court’s attorney fee award was “clearly wrong” or that the trial court otherwise abused its discretion in determining the amount of the attorney fee award. Id.
(1) Transfers of ownership interests need not directly reference a non-solicitation agreement for section 16601 to apply. As we previously discussed, courts may enforce non-competition covenants contained within separate agreements that were executed pursuant to the sale of a business. The present court’s holding is consistent with Fillpoint, LLC v. Maas (2012) 208 Cal.App.4th 1170 in that both courts used two separate agreements in applying section 16601. The present court went a step further than the court in Fillpoint by interpreting Owen’s contribution agreement in conjunction with Owen’s employment agreement, despite the documents not cross-referencing each other. See 74 Cal. App. 5th at 554.
(2) Section 16601 applies to joint ventures and may even apply if the transferor owns the transferee. The sale of business exception may apply to those who transfer all their business entity ownership interests to a separate entity. What if the transferor owns the transferee? Here, Owen owned all Blue Mountain membership shares when he transferred his entire ownership interests in the Blue Mountain Entities to Blue Mountain. The court cited Curci Investments, LLC v. Baldwin (2017) 14 Cal.App.5th 214 in reminding Owen that, no matter Owen’s ownership of Blue Mountain, Blue Mountain is a separate legal entity. See 74 Cal. App. 5th at 552. Therefore, Owen’s ownership of Blue Mountain was no bar to enforcing the non-solicitation covenant pursuant to section 16601. After all, Owen “dispos[ed] of all of his … ownership interest” under the Contribution Agreement while concurrently agreeing under the Employment Agreement to “refrain from carrying on a similar business within a specified geographic area in which the business so sold.” See 74 Cal. App. 5th at 554. The Court found it was undisputed that both contracts, along with other contracts the parties executed, were drafted to accomplish the Blue Mountain joint business venture. Id.
(3) Post-termination non-solicitation of customers provisions of at least three years may be enforceable if an applicable exception to section 16600 exists. The trial court enforced the post-termination non-solicitation of customer provision for approximately three years from the employee’s termination pursuant to its term. See id. at 553. The Court of Appeal found that there was no material dispute that existed as to the enforceability of the contractual provision prohibiting Owen from soliciting Blue Mountain’s customers and affirmed summary adjudication. Id. at 554. Parties drafting such covenants should ensure that they are tailored to the seller’s contractual promise to refrain from soliciting the sold business’s customers. See Strategix, Ltd. v. Infocrossing West, Inc. (2006) 142 Cal.App.4th 1068, 1072-1073.
(4) There is a fine line between “solicit” and “advertisement.” The court in Aetna Bldg. Maintenance Co. v. West (1952) 39 Cal.2d 198 set it straight: informing prior customers of one’s change of employment is not a solicitation by itself. Meanwhile, solicitation entails some modicum of a call to action. Here, Owen addressed his letter to “past and potential future clients.” Id. at 556. The letter was in no short supply of praise for the experience and innovation of Owen’s new business. Although the letter made no explicit request for business, the court read between the lines and held the letter to be a solicitation as a matter of law. Id.
(5) Attorney fees and costs can be substantial for enforcing lawful covenants. Aggrieved purchasers can recoup their fees and costs in whole or part if forced to bring actions against sellers who fail to honor their restrictive covenants. Purchasers should consider including prevailing party provisions in applicable buy-sell transactional documents.