Business-to-business contracts often concern trade secrets. Contracts such as NDAs, joint development agreements, license agreements, vendor agreements, and other commercial agreements commonly contain restrictive covenants relating to the protection of trade secrets or other protectible interests. But when do these terms constitute an illicit restraint of trade under California law? The California Supreme Court just addressed this very question in Ixchel Pharma v. Biogen , holding that most B2B agreements are governed by the common law rule of reason, instead of the flat prohibition on noncompetes applicable to the employment context.
Ixchel and Forward Pharma entered into an agreement to jointly develop a drug for the treatment of a disorder called Friedreich’s ataxia. The drug development went according to plan until Forward decided to withdraw from the agreement, as allowed by its terms, pursuant to a settlement with third-party Biogen. Under its agreement with Biogen, Forward agreed to avoid all partnerships with companies dealing in similar drugs.
Ixchel sued Biogen in federal court for tortiously interfering with Ixchel’s contractual and prospective economic relationship with Forward, claiming that Biogen did so in violation of California Business and Professions Code section 16600. After losing in the district court, Biogen appealed to the Ninth Circuit, which asked the California Supreme Court to decide, inter alia, how Section 16600 applies to the settlement provision requiring Forward to terminate its agreement with Ixchel. The court rephrased this question as “Does section 16600 of the California Business and Professions Code void a contract by which a business is restrained from engaging in a lawful trade or business with another business?”
In answering this question, the Court first noted the broad language of section 16600, which suggests that any part of an agreement restraining any party from engaging in a trade, profession, or business is per se invalid unless certain statutory exceptions apply. The Court agreed with the parties that Section 16600 does apply to business to business contracts, and that none of the statutory exceptions applied to this context.
The Court then considered the language of Section 16600 in its statutory context, and in light of precedent construing the prior iteration of Section 16600. Section 16600 was initially enacted in 1872 as Section 1673 of the Civil Code using substantively identical language. The court found that case law concerning Section 1673 generally invalidated noncompetes, while invalidating other contractual restraints on businesses operations and commercial dealings only when such restraints were unreasonable. Noting it had construed another antitrust statute, the Cartwright Act, to permit reasonable restraints of trade, the Court concluded that a rule of reason applies to business to business contractual restraints under Section 16600. The Court did not apply to the rule of reason to the contract at issue because of the posture of the case (motion to dismiss). Thus, the district court will be tasked with applying the rule of reason to the facts of the case as they develop during litigation.
This decision supports the notion that agreements protecting trade secrets, while still subject to scrutiny under Section 16600, may be enforceable so long as they are reasonable within the context of the businesses and their relationships, per caselaw developed under the Cartwright Act. The decision leaves numerous questions unanswered, such as the interaction between the rule of reason and the statutory exceptions to Section 16000. Businesses are urged to review such agreements in light of this decision, and to confer with experienced counsel when questions arise.