A California court has affirmed California’s established policy against covenants not to compete. In Kelton v. Stravinski, the court limited a non-compete agreement between two partners to only those specific business activities described in the partnership agreement.
Section 16600 of the California Business & Professions Code generally provides that every contract that restrains a person from engaging in a profession, trade or business is void, subject to specified exceptions. California courts have generally refused to enforce any non-compete agreement that does not fall within one of the statutory exceptions.
In Kelton, two individuals created a general partnership to develop warehouses. On forming the partnership, the partners signed a covenant not to compete which prohibited either partner from designing, building or operating any warehouse outside of the partnership. The partners subsequently amended their partnership agreement to limit the partnership activities to a specific series of development projects, but did not amend the non-compete agreement. Upon learning of the outside development activities of his partner, the plaintiff (Kelton) initiated a lawsuit on the grounds that his partner’s activities violated their covenant not to compete. The court ruled in favor of the defendant (Stravinski), holding that "an ongoing business relationship is not sufficient to validate a non-compete agreement that is void under Section 16600."
The Kelton court acknowledged that Section 16404(b)(3) of the California Corporations Code specifically provides that a partner has a duty to refrain from competing with the partnership in the conduct of the partnership business before dissolution of the partnership. However, the court also noted that this partnership’s business was limited to specific warehouse projects and, therefore, a broader non-compete agreement purporting to prohibit all warehouse development is void as a general matter. The Kelton decision limits the enforceability of a covenant not to compete to those business activities within the scope of the partnership agreement.
Covenants not to compete continue to be heavily scrutinized in California. Partnerships are best served by drafting covenants not to compete narrowly, with careful consideration given to the description of the partnership’s business. Prohibitions on conduct should be limited to business activities described in the partnership agreement. To the extent that a partnership agreement is limited to specific activities, covenants not to compete will provide protection only for those activities.
For further information, please contact David Sands at (213) 617-5536.