California Court Clarifies Noncompete Rules for Partial Business Sales and LLC Members
Author: Destiny Aigbe
December 5, 2024
In a groundbreaking decision, the California Court of Appeal in Samuelian v. Life Generations Healthcare, LLC clarified two significant issues under California noncompetition laws:
- Partial Sale Noncompetes: A partial sale of a business interest can support a noncompete agreement under the rule of reason, even if the sale does not meet the statutory exception for a complete transfer of ownership under Business & Professions Code Section 16601.
- LLC Membership Noncompetes: A noncompete may be enforceable during an individual’s period of LLC membership if the company’s operating agreement imposes contractual fiduciary duties on members.
CONTEXT OF THE SAMUELIAN CASE
The case arose when two LLC members sold a portion of their ownership interest while retaining minority stakes with voting and information rights. Their LLC operating agreement imposed fiduciary duties on members, including a noncompete clause during membership. When the members allegedly violated this clause, the LLC enforced its contractual right to purchase their remaining interests.
The selling members argued the noncompete was void under California’s strict noncompetition laws, but the court evaluated the provision under the rule of reason, marking a significant departure from the “void per se” standard typically applied to employment-related noncompetes.
KEY TAKEAWAYS FROM THE RULING
1. The Rule of Reason for Partial Business Sales
- Court’s Analysis: Partial business sales do not fall squarely within the "void per se" rule under Section 16600. Instead, courts must assess the competitive impact of such noncompetes, considering whether they promote or harm competition.
- Evaluation Factors: Courts will review the facts of the business, the noncompete’s effects, and its rationale, focusing on whether the seller maintains an ongoing connection with the business.
2. Fiduciary Duties in LLCs and Noncompetes
- In-Term Restrictions: The court upheld that in-term noncompetes remain enforceable if tied to fiduciary duties.
- Contractual Obligations: While California law does not impose fiduciary duties on members of manager-managed LLCs by default, such duties can be created through an operating agreement.
PRACTICAL IMPLICATIONS FOR BUSINESSES
Structuring Noncompetes in Partial Sales
Businesses should carefully draft noncompete provisions tied to partial sales. Agreements should reflect reasonable restraints that support legitimate business interests without unnecessarily restraining competition.
LLC Operating Agreements
Including contractual fiduciary duties in LLC operating agreements can bolster the enforceability of in-term noncompetition clauses. Businesses must ensure these duties are clearly outlined to avoid legal challenges.
WHY THIS MATTERS
The Samuelian decision fills a gap in California’s noncompete laws, clarifying how courts will evaluate partial sales and LLC membership noncompetes. Businesses should consult with legal counsel to navigate these complexities and structure agreements that align with this evolving legal landscape.
For tailored advice on noncompetes and restrictive covenants in California, contact The Law Offices Of Destiny Aigbe PLLC.
About the Author
Destiny Aigbe
Managing Partner
Aigbe Law PLLC | Dark Alpha Capital
A Corporate and Securities Law Firm
With a robust foundation in law and finance, Destiny Aigbe has carved a distinguished career, underpinned by his pivotal role in orchestrating and managing complex transactions that have propelled companies to significant growth and market prominence. As a seasoned attorney and strategic advisor, Destiny has been instrumental in facilitating over $75 million in capital raises, demonstrating a keen acumen for securing funding and fostering investor confidence.
Destiny's leadership in the execution of six successful public listings, through meticulously structured reverse mergers and registration statements, showcases his adeptness in navigating the intricacies of the public markets and his capacity to guide companies through transformative growth phases. His involvement in five mergers as an operator further illustrates his versatile skill set, extending beyond legal expertise to include hands-on management and operational strategy, though these ventures did not involve funding.
Destiny's professional journey is marked by a commitment to excellence and a diverse range of experiences, from representing a wide spectrum of clients including public and private companies, and investment firms, to holding significant roles within the US government. His tenure with the US Department of State and the National Institutes of Health highlights his adaptability and his contribution to the advancement of entrepreneurial ventures in sectors like biotechnology and nanotechnology through strategic funding initiatives.
An alumnus of Vanderbilt University Law School, Destiny focused on Finance and Mergers & Acquisitions, further honing his expertise with a certificate in Law and Business. His foundational education in Finance was obtained with honors from the University of Maryland's Robert H. Smith School of Business, which laid the groundwork for his subsequent achievements in investment banking and legal practice.
Residing in the Washington, D.C. area, Destiny Aigbe continues to leverage his extensive experience and insightful leadership to drive innovation, growth, and success for his clients and the ventures he is involved with.
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