The Supreme Court Of California Clarifies The Legal Standards For Economic Torts And For California Business & Professions Code Section 16600 Claims
On August 3, 2020, a unanimous California Supreme Court clarified the legal standards for claims alleging tortious interference with contracts that are terminable at will and the substantive standard for review of alleged violations of California Business and Professions Code section 16600’s prohibition against restraints on the freedom to engage in a business. Ixchel Pharma, LLC v. Biogen, Inc., No. S256927, 2020 WL 4432623 (Cal. Aug. 3, 2020). On appeal from the Eastern District of California, the Ninth Circuit (Ixchel Pharma, LLC v. Biogen, Inc., 930 F.3d 1031 (9th Cir. 2019)) asked the California Supreme Court to answer two certified questions on unresolved issues of California law: (1) whether a plaintiff must plead an independently wrongful act to state a claim for tortious interference with a contract that is terminable at will; and (2) whether a contract is void under section 16600 where it restrains one entity from engaging in lawful business or trade with another entity.
According to the complaint, plaintiff Ixchel Pharma, LLC (“Ixchel”) and Forward Pharma A/S (“Forward”), two biotechnology companies, entered into an agreement to jointly develop a drug containing an active ingredient called dimethyl fumarate (“DMF”). Under this agreement, Forward could withdraw “at any time” with 60 days’ notice of termination. Forward exercised its right to terminate its agreement with Ixchel because Forward entered into a settlement agreement with another biotechnology company, defendant Biogen, Inc. (“Biogen”) to settle a patent dispute. Under the settlement agreement with Biogen, Forward was required to terminate its agreement with Ixchel and was restrained from working with Ixchel or anyone else to develop drugs or treatments containing DMF. Ixchel sued Biogen in federal court for, among other things, tortious interference with contractual relations. After the district court dismissed Ixchel’s complaint twice, Ixchel appealed to the Ninth Circuit. The Ninth Circuit then requested the California Supreme Court to answer two certified questions to resolve whether Ixchel was required to plead that Biogen committed an independent wrongful act to state a claim for tortious interference with contractual relations and whether Biogen’s settlement agreement with Forward is void as a violation of section 16600.
With regard to the first question, after a discussion of the historical development of the law, the California Supreme Court turned to the policy interests implicated in economic torts. “The purpose of the independent wrongfulness requirement in economic interference torts,” the Court wrote, “is to balance between providing a remedy for predatory economic behavior and keeping legitimate business competition outside litigative bounds. ” Generally speaking, parties not restrained by contract should be free to compete for business, but where “economic relationships have solidified into binding future promises, the stability of the business relationship takes precedence over business competition.” But if a contract is terminable at will, the parties have agreed to a structure that provides “no legal assurance of future economic relations.” Under these circumstances, the threat of an interference with contract tort risks chilling efficient economic conduct. Thus, the Court concluded that plaintiff must allege an independently wrongful act, not just competition for the contract, to state a claim for tortious interference with an at-will agreement.
This led the Court to the next question—the proper standard for evaluating a contract alleged to violate section 16600 of California's Business and Professions Code—based on plaintiff’s contention that the non-compete provisions relating to DMF drugs in the Forward/Biogen settlement agreement were an independently wrongful act as an improper restraint of the freedom to engage in a business or trade in violation of section 16600.
Section 16600 provides that “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 statute has long been interpreted generally to prevent the enforcement of non-compete agreements in the employment context as per se invalid without regard to reasonableness, but the Court had never specifically addressed the proper standard to be applied to contracts that restrain a business from entering a trade or business. Not surprisingly, plaintiff advocated for a per se standard similar to the employment context, while defendant favored the rule of reason. After a lengthy analysis of the development of the law, the Court concluded that in light of the potential pro-competitive effects of contractual restraints on businesses entering a business or trade, the Court held that a contractual restraint of one business from engaging in lawful business or trade with another business must be analyzed under the rule of reason for claims arising under section 16600.
This opinion is useful in providing clear guidance both for firms competing for a contract and for firms negotiating contracts where some restrictions on some aspects of competition might be necessary to achieve pro-competitive ends. It is also consistent with the overall scheme of California’s (and federal) antitrust laws. It would be anomalous to condemn the wide variety of potential agreements between businesses that could restrain entry into a new business under a per se standard without an analysis of their competitive effects. And this decision does not limit the categories of hard-core cartel behavior, such as naked market or customer allocation schemes, that are still subject to per se condemnation under California’s Cartwright Act (or the Sherman Act).