The California Supreme Court answered two questions in its opinion in Ixchel Pharma, LLC v. Biogen, Inc., clearing up uncertainty in California’s business tort law.

  • Is a plaintiff required to plead an independently wrongful act in order to state a claim for tortious interference with a contract that is terminable at will?
  • What is the proper standard to determine whether section 16600 of the California Business and Professions Code voids a contract by which a business is restrained from engaging in a lawful trade or business with another business?

Providing guidance on the bounds of legitimate business competition under California tort and antitrust law, the Court held that: (1) To state a claim for tortious interference with an at-will contract, a plaintiff must plead and prove an independently wrongful act, beyond interfering with the contract itself (overruling conflicting lower court decisions which did not require an independent wrongful act); and (2) California’s statutory prohibition on contract provisions restraining trade-when applied to one business restraining another-is subject to the same rule of reason analysis prescribed by antitrust common law (as opposed to the strict analysis under Business and Professions Code §16600, which deems contracts in restraint of trade to be void except under certain very specific circumstances).

Historically, California has long recognized two related but distinct economic relations torts: interference with the performance of a contract and interference with a prospective economic relationship. California Courts originally treated both torts generally the same; the only difference was that interference with contractual relations required the existence of a binding contract. The decision in Della Penna v. Toyota Motor Sales, U.S.A., Inc. (1995) 11 Cal.4th 376, however, drew a sharper “distinction between claims for the tortious disruption of an existing contract and clams that a prospective contractual or economic relationship has been interfered with.”

In Della Penna, the Court held that a plaintiff seeking to recover damages for interference with prospective economic advantage (a business relationship which has not yet been formalized with a contract but which is likely to lead to a future business relationship) must plead as an element of the claim that the defendant’s conduct was “wrongful by some legal measure other than the fact of interference itself.” An act is independently wrongful if it is “unlawful, that is, if it is proscribed by some constitutional, statutory, regulator, common law, or other determinable legal standard.”  A plaintiff asserting intentional interference with a contractual relationship it had with another person or entity did not have to establish such an “independent wrong,” as the existence of contractual relationship itself warranted additional protection which simply does not exist in a prospective business relationship.

Relying on this framework, the California Supreme Court found that interference with an at-will contract more closely resembles interference with prospective economic advantage, rather than interference with contractual relations. The Court concluded that “like parties to a prospective economic relationship, parties to at-will contracts have no legal assurance of future economic relations.” Therefore, stating a claim for interference with an at-will contract required pleading an independent wrongful act. The Court reasoned that allowing claims of interference with at-will contracts without requiring independent wrongful conduct would risk chilling legitimate competition and could “expose routine and legitimate busines competition to litigation.” The Court also differentiated contracts not terminable at-will for their concreteness and bargained-for intentions, each of which provides legal assurances of future contractual relations that the contracting parties must rely on to make business decisions.  In at-will contracts, neither party can justifiably bank on the other’s future performance, because such performance is speculative.

The Court next addressed the question of the proper interpretation of California Business & Professions Code §16600. The California Supreme Court had not previously decided whether Section 16600 applies to contracts between two businesses, or only to contracts between employers and employees. Section 16600 provides that except for certain statutory exceptions “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void”. In Ixchel, the California Supreme Court provided guidance not only on whether section 16600 applies to contracts between two businesses but also on the proper standard to evaluate whether restraints on trade in business contracts are void under section 16600.

Plaintiff in Ixchel took the position that the statutory language of section 16600 is unambiguous and not limited to the employment context. Pointing to Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937, Plaintiff argued that the public policy underlying the statute should be applied broadly to bar contracts restraining a business from engaging in lawful business activity. The California Supreme Court disagreed with this position. The Court reasoned that adopting Plaintiff’s position would result in substantial uncertainty and economic harm. The Court, addressing the practical implications of Plaintiff’s position, explained that in certain circumstances, contractual limitations on the freedom to engage in commercial dealings can promote competition. “Contractual limitations help businesses ensure stability in supply or demand, protect their research, development, and marketing efforts from being exploited by contractual partners.” Further, the Court found that “contractual limitations between businesses can have a procompetitive effect since they enable long-term planning on the basis of known costs, providing greater market predictability.”

The Court discussed previous cases invalidating contractual restraints in the business context and reasoned that those decisions did not invalidate contractual provisions merely because they restrained trade in some way. Instead, the Court examined the purpose of the contracts at issue, or in other words, conducted a reasonableness inquiry. The Court found contracts invalid when their purpose was to restrain trade that harmed the spirit of competitive business practices such as creating a monopoly, restricting supply, or fixing prices. After a thorough review of precedent construing section 16600, the Court held that California applies a reasonableness standard to contractual restraints on business operations and commercial dealings, although courts have not always stated this in previous opinions.  Therefore, contracts with the purpose and effect of promoting trade and competition are valid, even if their terms incidentally restrain commercial freedom in some manner.

Now that the California Supreme Court has weighed in on these two issues, there will be a bit less guesswork as to how interference claims with at-will contracts and non-competition provisions in business-to-business contracts will be dealt with by California’s courts.  If you have questions as to how this decision may affect your business going forward, please do not hesitate to reach out to the NavBat team.