What is the current state of California divorce concerning covenants not to compete?
The Business Professions Code, voids any agreement that restrains an individual form engaging in a lawful occupation or enterprise except as otherwise provided by statute. However, in divorce, the state’s policy favoring an individual’s right to freely practice their chosen trade or profession requires that any restrictions be based upon evidence showing that those restrictions are reasonably necessary to preserve the value of the asset awarded to the other party in the division of marital property.
The seminal divorce case concerning covenants not to compete is In re Marriage of Greaux and Mermin (2014) 223 Cal.App.4th 1242. During their marriage, husband and wife created Saint Bart’s Spirit Company ("SBSC"). Husband used his business skills to gain customers for SBSC, contributed her family contacts in the Caribbean, and had product-specific knowledge. As their marriage went south, wife engaged in conduct detrimental to SBSC’s business.
At their divorce trial, wife's divorce lawyer asked the divorce court to award SBSC to wife as expert testimony showed it had no value and that husband had run SBSC into the ground. The divorce court pointed out that an expert had valued SBSC at $49,000, which was completely offset by husband’s post-separation contributions of between $43,000 and $70,000 to keep SBSC going. The divorce court awarded SBSC to husband, finding that he had shown he could operate the business under adverse circumstances, while wife appeared willing to sacrifice the interests of SBSC for seemingly little more than spiteful retribution. In a statement of intended decision, the divorce court ordered Wife to surrender her SBSC stock, to execute all necessary documents, and to refrain from further conduct intended to harm SBSC in any way. The divorce court also ordered Wife to be subject to a five-year noncompetition order.
When the husband, through his divorce lawyer, prepared a proposed statement of decision, husband included a covenant not to compete that restrained wife from competing with him or SBSC for five years from the date of the divorce judgment. The noncompetition divorce order also prevented the wife from consulting with or working for any of SBSC’s competitors. The wife's divorce lawyer opposed the divorce court order, claiming that it violated Business Professions Code section 16600 – which voids any contract which restrains anyone from engaging in a lawful profession, trade, or business is void. She also asserted that the divorce court lacked the authority to make such an order in the divorce action. The divorce court, however, did not disagree. It adopted husband’s divorce lawyers proposed statement of decision, including the covenant not to compete.
Wife's divorce lawyer appealed. The First District reversed and remanded.
The Divorce Court’s Authority to Issue Orders in Family Law Proceedings Outweighs The Public Policy in Favor of Open Competition
The Wife, through her attorney, contended that the divorce court exceeded its jurisdiction by issuing the noncompetition family law order and that it did not have the authority to issue such an order in a divorce proceeding. In addition, she argued that the noncompetition family law order violated California’s strong public policy in favor of open competition. The Husband, through his attorney, countered that the relevant statutes in the Business and Professions Code do not specifically preclude the divorce court from issuing such a family law order, which it could do in line with its power to make any family law orders necessary to effect an equal division of the parties’ community property in a divorce. The justices reasoned that B&P C § 16600 not only precludes contracts that restrict business or employment but also reflects the state’s policy favoring open competition. However, the panel found, the state has an equally important interest in ensuring that the parties’ community property is divided fairly and equally in divorce proceedings. The appellate court concluded that the state’s interests in fair and equal distribution of community property in a divorce outweighed public policy in favor of competition. Therefore, they determined, the trial court had the authority to make a noncompetition order against Wife in order to preserve the value of SBSC, as awarded to Husband.
A Divorce Court May Make a Noncompetition Order to Preserve the Value of Goodwill
The justices reasoned that covenants not to compete are routinely part of the sale of a business or the dissolution of a corporation or partnership. These clauses protect the value of the goodwill of the business. In the same way, when a divorce court awards a family business to one spouse, the divorce court must determine whether the business includes goodwill. If so, the divorce court may make a covenant not to compete to preserve the goodwill awarded to a spouse in the divorce. The panel could find no prior California divorce case that had specifically authorized such an order, but found several out-of-state divorce cases that were largely in accord, such as Carr v. Carr (1985) 108 Idaho 684, in which the divorce court dealt with the sale of the family business, a truck stop, that was to be sold to third parties. When the husband objected to having a covenant not to compete included in the sale (because he wanted to open a truck stop on adjacent property after the divorce), the divorce court ordered him to sign the documents. He did so and then appealed, but to no avail. The Idaho appellate court reasoned that the business had a goodwill component that would be protected by the noncompetition covenant and could be made a part of the divorce court’s judgment. The panel here agreed with Carr's reasoning, but not with the other out-of-state divorce cases that had reached different conclusions.
Noncompetition Orders In a Divorce Must Be Limited In Scope
Having determined that the divorce court could make noncompetition orders a divorce order, the panel considered the permissible scope. Noncompetition orders found no California divorce case that addressed the question and turned to out-of-state cases. The justices noted that in Lord v. Lord (Me. 1983) 454 A.2d 830, the Maine divorce court held that the divorce court could make a noncompetition orders in connection with its award of the family insurance agency to the husband in a divorce but a noncompetition orders needed to ensure that the restrictions the order placed on the wife were not “unduly harsh, without an adequate evidentiary basis for their necessity.” The court believed that "noncompetition orders must be reasonable and not broader than necessary to protect the good will included in the valuation and transfer.” The California Court of Appeal panel also recognized that other states have limited the scope of an order to “a specified geographic area” where the business was conducted, and they agreed with that restriction, absent evidence that a broader scope was necessary to protect the value of the business. Here, the panel found that the divorce court had abused its discretion by failing to determine the proper geographic scope of the noncompetition orders to make findings as to why the scope of the divorce order should not be limited. Accordingly, the justices reversed the part of the divorce judgment pertaining to the noncompetition divorce order and remanded it for further proceedings consistent with this opinion.
Where there is a goodwill component in the business, the divorce court may make a noncompetition order to protect the value of the asset after the divorce. In the leading divorce case on this issue, In re Marriage of Greaux and Mermin (2014) 233 Cal.App4th 1242, a reversal of the court below, the First District held that a divorce court that awards a community property business to one spouse in a divorce has the authority to issue a noncompetition order against the other spouse in order to preserve the value (i.e. the goodwill or trade secrets) of the underlying asset after the divorce. However, the divorce court’s order must restrict its scope to the geographic area where the parties conducted their business absent evidence that a broader scope is needed. Finally, care should be used in determining and drafting the proper scope of the noncompetition clause to avoid future litigation of the divorce judgment relative to interpretation.