California generally prohibits non-compete agreements, but selling a business can change the analysis. A buyer purchasing customer relationships and goodwill may have a legitimate reason to restrict the seller from immediately opening a competing operation. That does not make every restriction in an acquisition enforceable. This article explains California’s sale-of-business exception, which transactions can qualify, and what buyers and sellers should review before signing.
California’s starting rule: non-competes are void
California Business and Professions Code § 16600 generally makes contracts void to the extent they restrain someone from engaging in a lawful profession, trade, or business, subject to statutory exceptions. Section 16600.1 additionally makes it unlawful for an employer to include a non-compete clause in an employment contract or require an employee to enter a non-compete agreement unless a statutory exception applies. In Edwards v. Arthur Andersen LLP, 44 Cal.4th 937 (2008), the California Supreme Court rejected a proposed “narrow restraint” exception for employment non-competes.
For California businesses, this means an ordinary employment agreement cannot prevent a departing employee from working for a competitor simply because the restriction lasts only a short time or covers a small territory. Calling the restriction reasonable does not create an exception.
A genuine sale of a business is different. Business and Professions Code § 16601 permits certain seller restrictions tied to the transfer of ownership or goodwill. Separate statutory exceptions also address specified partnership and limited liability company departures under §§ 16602 and 16602.5. This article focuses on business sales.
Non-compete sale of business: California’s narrow exception
Section 16601 protects the value of what the buyer actually purchases. Goodwill generally means the business’s established customer relationships, reputation, and expectation of continued patronage. If a seller transfers that value and immediately competes for the same customers, the buyer may lose part of the bargain.
The statute identifies qualifying transactions that include:
- A person selling the goodwill of a business.
- An owner selling or otherwise disposing of all of that owner’s ownership interest in a business entity.
- Specified sales involving all or substantially all operating assets together with goodwill, including qualifying sales of a business division or subsidiary.
- A qualifying sale of all ownership interests in a subsidiary.
The transaction’s substance matters. A purchase of selected equipment without goodwill is not automatically a qualifying sale. Likewise, an owner selling only part of an ownership stake should not assume that the ownership-transfer branch of § 16601 applies.
Buyers and sellers should examine the transaction documents, ownership records, and assets being transferred. Describing a payment as “goodwill” does not, by itself, establish that a legitimate transfer occurred.
The restriction must match the business being sold
A qualifying sale is only the first step. In connection with a qualifying transaction, § 16601 permits a seller to agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the sold business was carried on, so long as the buyer—or a person deriving title to the goodwill or ownership interest from the buyer—continues to carry on a like business there.
That makes the scope of the restriction important. A seller of a local specialty business should question a clause that prohibits every kind of work across unrelated industries or territories. A business serving customers throughout California presents different facts from one operating in a single neighborhood.
- Restricted activities: Identify the similar business the seller cannot operate, rather than using an unlimited ban on commercial activity.
- Geographic area: Connect the territory to where the sold business actually carried on business.
- Duration: If the parties use a fixed term, state it clearly, and account for the statute’s requirement that the buyer or qualifying successor continue a like business in the area. Section 16601 itself does not prescribe a particular duration.
- Permitted activities: Clarify unrelated ventures, existing investments, and other activities the parties intend to allow.
A broad definition of “competition” can create disputes even when both sides agree that some restriction is appropriate. Drafting should reflect the purchased business, not just the buyer’s future expansion plans.
Employment restrictions need separate scrutiny
Many sellers remain with the acquired business as employees or consultants. That arrangement can create two different agreements: a restriction protecting the purchased goodwill and a restriction aimed at controlling the seller’s later employment.
In Fillpoint, LLC v. Maas, 208 Cal.App.4th 1170 (2012), the court upheld the three-year sale-related covenant in the stock-purchase agreement as directed at protecting acquired goodwill, but held the broader noncompetition and nonsolicitation covenant in the employment agreement void and unenforceable under § 16600. The decision illustrates why acquisition paperwork does not automatically validate every non-compete signed at closing.
A buyer should not assume that a valid seller covenant permits an additional post-employment ban. A seller should review the purchase agreement, employment agreement, consulting agreement, and related documents together. Different start dates, overlapping restrictions, or language extending beyond the transferred goodwill can materially change the analysis.
What buyers and sellers should review before closing
Non-compete terms belong in the transaction review, not in a last-minute closing checklist. An attorney advising on mergers and acquisitions can evaluate how the proposed restriction connects to the ownership transfer, goodwill, and ongoing business.
- Confirm the qualifying sale. Identify which statutory category applies and what interests, assets, and goodwill are being transferred.
- Document the business’s footprint. Preserve information about locations, customers, services, and markets supporting the proposed territory.
- Compare every agreement. Check purchase, employment, consulting, and confidentiality provisions for inconsistent or overlapping obligations.
- Assess enforcement provisions. Review remedies, dispute procedures, and choice-of-law language without assuming they can cure an invalid restraint.
Do not assume a court will rewrite an overbroad clause. Resolving scope questions before signing is generally more practical than disputing them after the seller starts a new venture.
Talk to a California business attorney
Itkin Law offers free consultations for buyers and sellers evaluating non-compete provisions in a California business sale. Schedule a free consultation or call (424) 603-8888.
This article is attorney advertising and provides general information only. It is not legal advice and does not create an attorney–client relationship. The law changes, and this article reflects the law as of its publication date. Every situation is different — contact us to discuss how the law applies to your exact circumstances. See our full disclaimer.
