The General Rule: Unenforceable by Design
California has a long-standing and deeply rooted public policy that favors employee mobility and open competition. This policy is codified in California Business and Professions Code § 16600, which states:
“Except 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.”
California courts have consistently read this prohibition broadly and literally. The California Supreme Court reaffirmed this position in the landmark case of Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937, in which it definitively rejected the “narrow restraint” exception previously applied by some federal courts whereby certain non-compete agreements that did not “entirely preclude” an employee from practicing his or her trade had been upheld. The Court made clear that any employment non compete is void — no matter how narrowly tailored — unless it falls within a statutory exception explicitly set out in the Business and Professions Code.
This uncompromising stance reflects legislative intent and judicial interpretation that employee mobility drives innovation and economic growth, particularly in sectors like technology and life sciences that rely on human capital.
The M&A Exception: A Limited Universe
While the general rule is clear, there is one critical exception that every M&A practitioner in California must understand. § 16601 of the Business and Professions Code allows a seller of a business to agree with the buyer not to compete, but only where certain conditions are satisfied – namely, (i) the seller is selling the goodwill of a business (or owns a business entity selling all or substantially all of its or a division or subsidiary’s assets, including goodwill) or (ii) the seller is selling all of his or her ownership interest in the business (or owns a business selling all of the ownership interest of a subsidiary). The statute provides in relevant part:
"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, or any owner of a business entity that sells (a) all or substantially all of its operating assets together with the goodwill of the business entity, (b) all or substantially all of the operating assets of a division or a subsidiary of the business entity together with the goodwill of that division or subsidiary, or (c) all of the ownership interest of any subsidiary, may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business so sold... has been carried on, so long as the buyer... carries on a like business therein."
The purpose of § 16601 is straightforward: to protect the goodwill of the acquired business so the seller cannot undermine its value by immediately competing. Courts, however, construe this exception narrowly — which means compliance with every statutory element, including goodwill, ownership transfer, geographic scope, and continued operations of a like business, is essential.
The Devil in the Details: Key Statutory Components
The exception under § 16601 is not a free pass; it is tightly limited and requires strict adherence to its components.
1. Geographic Limitations and Duration
The statute specifies that the non compete must be within a “specified geographic area in which the business… has been carried on.” This can be challenging for modern technology companies where operations are often national or global from day one.
California courts apply this requirement literally. In Alliant Ins. Servs., Inc. v. Gaddy (2008) 159 Cal.App.4th 1292, the court upheld a non compete covering the entire state of California because the business serviced clients statewide. The key was a demonstrable alignment between the scope of the covenant and the seller’s actual operational footprint at the time of sale.
In contrast, in Strategix Ltd. v. Infocrossing West, Inc. (2006) 142 Cal.App.4th 1068, a non solicit provision was struck down for being overbroad and untethered to the goodwill actually purchased.
While, in theory, a worldwide restriction might be enforceable if the seller’s business demonstrably operated on a global scale, such outcomes are rare in practice and will be heavily fact specific. Practitioners must be ready to prove the match between geographic scope and actual operations with concrete evidence.
Note that California does not “blue pencil” and therefore will not revise a non-compete to reduce it to a geographic scope that would be enforceable; rather, when evaluating the enforceability of a non-compete before it, a California court will give it a simple thumbs up or thumbs down.
Likewise, although California has never opined on the maximum duration of a non-competition agreement, legal practitioners generally view a 3 or 4 year duration following the closing of a transaction as the limit of what California would tolerate absent special facts and circumstances. Another practice point: Don’t be tempted to tie it to 3 or 4 years following termination of employment; again, the risk is that the non-compete would then be viewed as being entered into in connection with employment rather than in connection with the M&A deal and therefore would be void under California law.
2. Ownership
As noted above, § 16601 includes an exception for a seller who is an “owner of a business entity selling or otherwise disposing of all of his or her ownership interest.” This exception raises a few recurring issues in California M&A deals:
Applicability to “partial sales”: Does the reference to “all” of an ownership interest in the statute preclude a non-compete from being viable where an owner sells only a partial interest? On its face, yes. However, in the 2024 case Samuelian v. Life Generations Healthcare, LLC (2024) 104 Cal. App. 5th 331, 341, the California Court of Appeals added nuance to this interpretation in reviewing a partial sale of a business. There, the Court found that a non-compete binding the continuing owners was not “inherently anticompetitive”, because of the owners continuing control over operations of the business and receipt of confidential information about the business, and should instead be evaluated under a reasonableness standard. The Samuelian case should be viewed with caution at this stage given the lack of clear guidance on “reasonableness” (and the fact that the language of § 16601 remains unchanged), but it does open the door going forward to non-competes being possible in the context of partial sales.
The de minimis problem: Even where “all” of an ownership interest is sold, how much of an ownership interest is enough? The statute is silent on any minimum threshold. Although no California appellate court has set a definitive percentage, practitioners often advise avoiding non competes for sellers with only a token interest (e.g., less than 1%) to avoid claims that the covenant is a “sham” designed to restrain an employee. Language in the Samuelian decision supports this proposition, as the Court there suggested that a non-compete tied to the sale of a mere 1% interest would likely be invalid per se. Courts are also likely to scrutinize whether the sale was a bona fide transfer of an ownership stake tied to goodwill. In practice, the people a buyer wants to retain the most will almost always hold more than 1% given California’s culture of equity awards for technology and life sciences employees. But what if they just own options they haven’t exercised?
The stock option dilemma: In California, an unexercised stock option is not ownership — it is merely a contractual right to acquire ownership in the future; in other words, a contingent right to acquire ownership. If a key employee or founder holds only unexercised options at closing, they have not sold an ownership interest, and a § 16601 non compete cannot be enforced against them. Very good law firms offer very different advice on how to handle this situation. Inevitably, someone from the buyer’s business team will eventually say: Let’s just give it a try, okay? Worse case, it won’t be enforced. That is the moment good lawyers need to step in.
No Harm, No Foul? The High Stakes Litigation Risk
Faced with the statutory constraints, some may be tempted to “just include” a non compete and take their chances. If unenforceable, the thinking goes, the only cost is having it struck down. That thinking is wrong. The California Court of Appeals has made clear in Silguero v. Creteguard, Inc. (2010) 187 Cal.App.4th 60 and other cases that even attempting to enforce an unlawful restraint can be actionable by an employee. In addition, other companies can sue under the Unfair Competition Law and can make tort claims like tortious interference with business, both with fee shifting exposure.
As of 2024, CA politicians have also weighed in with new potential penalties:
- Senate Bill 699 (effective January 1, 2024) makes it unlawful to enter into or attempt to enforce a non compete void under California law, even if signed out of state, where the employee works in California.
- Assembly Bill 1076 (effective January 1, 2024) codifies the broad reading of § 16600 from Edwards and requires employers to notify certain current and former employees by February 14, 2024 that any non competes they signed are void.
These laws give employees a private right of action, including injunctive relief, damages, and mandatory attorneys’ fees awarded to a prevailing employee.
The Most Important Tool in the M&A Arsenal — When Used Precisely
In many West Coast M&A deals — especially in technology and life sciences — the acquisition is about more than IP or data; it’s about acquiring the human capital – the scientists, engineers, coders, AI experts, founders and other key employees. When properly deployed within § 16601’s narrow confines, a non compete can be one of the most important tools to protect that investment.
But the law is clear: in California, it is a targeted measure, not a blanket restraint. A § 16601 covenant must be drafted with precision, tied directly to the sale of goodwill or ownership, narrowly limited to the geographies where the business actually operates, and clearly tied to the deal rather than an arrangement entered into in connection with employment. Misusing it — or overreaching — can transform a valuable protection into a costly liability.