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Horvitz & Levy obtained reversal of a judgment confirming a $40 million arbitration award against its client and further established the enforceability of noncompetition provisions in its client’s operating agreement.
Horvitz & Levy’s client, Life Generations Healthcare, LLC, is a closely held company that owns and operates skilled nursing facilities throughout California and Nevada. Its operating agreement prohibits its members from competing with the company while they remain owners. Two of the company’s largest members sold part of their business interests in the company. Despite remaining minority members with significant rights to control the company and access its confidential, proprietary information, those two members allegedly began competing with the company in violation of the noncompetition provisions. Those members then opened an arbitration action against the company and its remaining members arguing the noncompetition provisions were invalid. At the beginning of the lengthy arbitration, the arbitrator ruled that the noncompetition provisions were per se invalid under Business and Professions Code section 16600 without regard to the provisions’ reasonableness. The $40 million arbitration award against the company that followed years later was built on that initial ruling. After arbitration, the superior court confirmed the award. Life Generations Healthcare retained Horvitz & Levy to appeal.
The Court of Appeal reversed, agreeing with Horvitz & Levy’s arguments in a published opinion. The Court of Appeal held that the arbitrator applied the wrong legal standard when invalidating per se the noncompetition provisions in the company’s operating agreement. Although the Supreme Court in Ixchel Pharma, LLC v. Biogen, Inc. (2020) 9 Cal.5th 1130, said that case law has generally invalidated agreements not to compete upon the sale of interest in a business without inquiring into their reasonableness, the Supreme Court did not consider whether a partial sale of interest in a business is invalid per se . Because of the potential procompetitive benefits of such agreements when owners sell only part of their interests in a company, such agreements are invalid under section 16600 only if unreasonable in light of the seller’s ongoing connection with the company. The Court of Appeal therefore reversed the judgment and directed the superior court to vacate the arbitration award.
