The Antitrust Attorney Blog

What is the Twombly Motion-to-Dismiss Standard for Antitrust Cases? Comparing the Ninth and Second Circuits

August 15, 2020 | Bona Law PC

As a long-standing antitrust attorney in Europe, making the decision to move from Madrid to San Diego a few years ago to practice law in the U.S. has been a life-changing experience. Both personally and professionally. Learning from other cultures, colleagues, and languages is something I strongly recommend to everyone. It opens your mind and provides you with a different perspective about the world and yourself. And of course, that also applies to the practice of law.

Indeed, when you move to a new jurisdiction you basically become a “newborn” attorney, but with all your past experience in the backpack. That puts you in the best position to approach everything with a “fresh pair of eyes”, which in turn allows you to add value to your team and cases in a unique way.

In that respect, something I noticed during these first years of practicing antitrust law in the U.S. is how district courts, in deciding motions to dismiss cases, disagree on the applicable standard when analyzing antitrust conspiracies. Some apply the summary-judgment or trial-like standard to conspiracy allegations, particularly when confronted with “non-parallel-conduct” cases, despite the fact that a complaint at that stage is constructed without the benefits of discovery. Others misunderstand the language in Twombly about “ruling out the possibility of independent action,”—which is specific to conscious parallelism cases—and they incorrectly add it to the list of pleading requirements.

What is the Biggest Mistake that District Courts Make in Antitrust Cases?

The Antitrust Pleading Standard Is Shifting Back Toward the Plaintiff

TWOMBLY AND THE PLAUSIBILITY STANDARD

For those not familiar with antitrust law, Bell Atlantic Corp. v. Twombly changed the antitrust pleading standards in federal court from one of “extreme permissibility” to the current “plausibility” standard. And that was a big deal because it basically re-defined what Federal Rule of Civil Procedure 8(a)(2) requires for a complaint to survive a motion to dismiss for failure to state a claim upon which relief can be granted under Rule 12(b)(6) FRCP.

In antitrust cases, a claim under Section 1 of the Sherman Act requires (i) a contract, combination, or conspiracy; (ii) an unreasonable restraint of trade in the relevant market; (iii) and antitrust injury.

For the first prong, there are two ways to prove a “contract, combination, or conspiracy”: (i) by direct evidence that shows the existence of an agreement; or (ii) through a combination of parallel conduct and “plus factors,” i.e., “economic actions and outcomes that are largely inconsistent with unilateral conduct but largely consistent with explicitly coordinated action.” In re Musical Instruments & Equip. Antitrust Litig., 798 F.3d 1186, 1194 (9th Cir. 2015).

Second, an unreasonable restraint of trade always involves some sort of antitrust illegal conduct such as fixing prices, allocating customers, a group boycott, or rigging bids, among many others.

Last, in order to survive a motion to dismiss, a complaint also requires antitrust injury. An antitrust plaintiff must show both constitutional standing and antitrust standing. If you want to know more about antitrust injury, we have written extensively on the subject.

The Elements of Antitrust Injury: A Two-Prong Test

Antitrust Injury and the Classic Antitrust Case of Brunswick Corp v. Pueblo Bowl-O-Mat

Here I will just focus on the two ways courts may prove a “contract, combination, or conspiracy”: (i) direct evidence, (ii) or circumstantial evidence and “plus factors”. This is the prong where district courts have been struggling when ruling on their motions to dismiss, mainly because Justice Souter’s opinion in Twombly included some language from the landmark summary-judgment decision (Matsushita) that the Court used to explain why in conscious parallelism cases, plaintiffs’ “offer of conspiracy evidence must tend to rule out the possibility that the defendants were acting independently.”

DIRECT EVIDENCE

Direct evidence in a Section 1 antitrust conspiracy means evidence that is explicit and requires no inferences to establish the conclusion that an agreement exists. In plain English, a “smoking gun” in the form of documents, meetings or defendants’ testimony.

Federal courts around the country have agreed––with very limited exceptions––that whenever a complaint includes such non-conclusory allegations of direct evidence of an agreement, there is no need to go any further on the question of whether such an agreement has been adequately pled. And this is important because it means that allegations of direct evidence of an agreement––if sufficiently detailed––are independently adequate and sufficient alone.

Bottom line, in direct evidence scenarios, there is no need to even carry out the Twombly “plausibility” analysis in the first place. To meet the direct evidence standard the evidence must explicitly support the asserted proposition without requiring any inference. In re Citric Acid Litig., 191 F.3d 1090, 1093 (9th Cir. 1999) (“Citric Acid”)

This is the only threshold that a plaintiff should meet in order to survive a 12(b)(6) motion to dismiss when providing direct evidence.

CIRCUMSTANTIAL EVIDENCE, PARALLEL CONDUCT AND “PLUS FACTORS”

But like everything meaningful in life, things are rarely that straightforward in antitrust law. Thus, in alleging a conspiracy, a plaintiff may present either direct evidence (or if that’s not possible), circumstantial evidence of defendants’ conscious commitment to a common scheme designed to achieve an unlawful objective. This is a mouthful, so let’s try to bring some light to it.

District courts have the power to insist on some degree of specificity in pleading before allowing an antitrust complaint relying on allegations of circumstantial evidence of agreement to proceed. That’s why the Supreme Court in Twombly offered some guidance as to how to properly plead an agreement in parallel conduct cases:

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The End of the Paramount Antitrust Consent Decrees: A Brief Look at Movie History and the Future

August 7, 2020 | Bona Law PC

Author: Steven Madoff

Steven Madoff was an Executive Vice President of Business and Legal Affairs for Paramount Pictures Corporation from 1997-2006.

The recent announcement by the Antitrust Division of the Department of Justice that it is planning to terminate the 70-year-old Paramount Consent Decrees leads to reflection on how culture, business models, the law, and technology intersect and impact one another.

The history of the motion picture business resonates with the evolution (and sometimes revolution) of technology, the industry’s adaptation of its business models to respond to these changes in technology and the impact of these changes and adaptations to cultural transitions and transformations.

Virtually from its birth in the early 20^th century, the motion picture industry attracted the scrutiny of governmental regulators. As early as the 1920’s, the U.S. Justice Department started looking into the trade practices and dominant market share of the Hollywood studios.

The Studio System

In the early 1930’s, the Justice Department found that the major studios were vertically-integrated monopolies that produced the motion pictures, employed the talent (directors, writers, actors) under long-term exclusive contracts, distributed the motion pictures and also owned or controlled many of the theaters that exhibited the movies. This was sometimes called the “studio system.”

Particularly troubling were the studios’ practices of block booking and blind bidding. Block booking is the practice of licensing one feature film or group of feature films on the condition that the licensee-exhibitor will also license another feature film or group of feature films released by the same distributor. Block booking prevents customers from bidding for individual feature films on their own merits. Blind bidding or blind selling is the practice whereby a distributor licenses a feature film before the exhibitor is afforded an opportunity to view it. These practices were particularly onerous when applied against independent theater owners not owned or affiliated with the studio-distributor.

It seemed like the time had come for the government to force the studios to divest their ownership of the exhibition side of the business. But the Depression intervened and the studios convinced President Roosevelt that the country needed a strong studio system to supply movie entertainment to the populous as a relief from tough economic times. President Roosevelt therefore delayed any action requiring the studios to divest their theaters under the goals of the National Industrial Recovery Act.

The Paramount Consent Decrees

But, by 1940, the Department of Justice filed a lawsuit against the studios alleging violations of Sherman 1 and 2—restraint of trade and monopolization. The claims were made against what were then called the Big Five Studios, all of which produced, distributed and exhibited films (MGM, Paramount, RKO, Twentieth Century-Fox and Warner Bros.) and what were called the Little Three studios, which produced and distributed films but did not exhibit them (Columbia, United Arts and Universal).

At the time, Paramount was the largest studio and exhibitor and was first-named in the lawsuit, and so in 1940 when the studios reached a settlement with the Department of Justice, the resulting arrangement became known as the Paramount Consent Decrees.

As part of the Consent Decrees, the Studios were not required to divest their ownership in theaters; however, block booking was dramatically cut back (e.g., no tying of short subjects to feature films and no “packages” in excess of five feature films) and blind bidding was prohibited. The parties agreed to a 3-year period for the Consent Decrees during which the Department of Justice would monitor compliance by the Studios.

By 1946, however, the Department of Justice had determined the Studios were not in compliance and brought the case back to the Federal District Court. After the trial, the Court ruled that the Studios could no longer engage in block booking, but did not require them to divest their ownership in theaters, which the Department of Justice had asked for. Both parties appealed the case, which eventually reached the US Supreme Court.

In a 7-1 decision, written by Justice William O. Douglas, the Court found, among other things, that block booking was a per se violation of Sherman 1 and in remanding the case to the District Court recommended that the Studios be ordered to divest their ownership in theaters. But before the District Court rendered a decision on whether the Studios should divest their theaters, one of the Big Five Studio defendants, RKO Pictures (then controlled by Howard Hughes) decided to sell its theaters. After that, another Big Five Studio defendant, Paramount, sold its theaters.

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Big Tech Hearings: What Do They Tell Us About Amazon and Antitrust?

August 4, 2020 | Bona Law PC

Author: Steven Cernak

The U.S. House Antitrust Subcommittee of the Judiciary Committee’s recent hearings into “big tech” and antitrust were “must see TV” for antitrust attorneys.

Over the five hours of testimony, many interesting questions were asked of the leaders of Apple, Google, Facebook, and Amazon; unfortunately, the format often left little time for answers. Because so many of our clients—manufacturers, retailers, and others—are active in the online retail space, we thought we would focus on Amazon and Jeff Bezos’s statement and answers.

These hearing are not the only antitrust scrutiny that Amazon is receiving. The FTC and the states of California and Washington appear to be investigating the company and its actions. Given all the publicly available information, what did the hearings teach us about the kinds of antitrust claims that might be made against Amazon in any antitrust suit?

Competing with Private Label Goods

Several of the questions involved allegations that Amazon had somehow “stolen” or misused data from some of its manufacturers or third-party sellers to determine which products it would begin to produce as private label goods. Many of these questions grew out of a long Wall Street Journal report in April. Bezos explained that Amazon’s policy is not to use data of an individual seller to make such decisions, although the company continued to investigate possible violations. Also, Bezos clarified that aggregate data, which he defined as data relating to at least two sellers, could be used by Amazon under its policy.

As commentators have pointed out, retailers deciding to sell private label goods along with, or instead of, branded goods is not inherently an antitrust violation; in fact, many retailers like Kroger’s and Costco obtain significant revenue from the practice. Bezos himself pointed out that Amazon’s policy limiting its use of data from the other sellers was “voluntary” and not required by any current law. One of the questions at the hearings hinted at an allegation that Amazon might be in a different position than other retailers, either because of its size or greater access to seller data; unfortunately, inadequate time was given for a response. Any antitrust actions here would need to be able to take on all private label goods sold by large retailers or explain why Amazon’s actions are uniquely anti-competitive.

Predatory Pricing

At least two sets of questions focused on potential “predatory pricing” by Amazon, that is, pricing products so low that competitors are forced out of the market. The first set involved allegations from many years ago that Amazon had drastically lowered prices on diapers to weaken Diapers.com, later renamed Quidsi before Amazon purchased it. In response to questioning, Bezos claimed to be unfamiliar with the details of pricing of one product nearly ten years ago. In the second set, Bezos was asked if Amazon ever priced Echo or Ring or other in-home assistants below cost. He claimed that the price of those products usually was above cost, although sometimes their prices might be below cost during periodic promotions.

As readers of this blog know, current law makes predatory pricing illegal only if a monopolist’s prices are very low, usually defined as below variable costs, and there is a chance that the monopolist can later raise prices to recoup its losses. Certainly, not enough time was spent on the topic during the hearings to address those details in these Amazon examples. Also, other commentators have already disputed the implications from the Quidsi story, describing it as another example of a retailer using a pro-competitive “loss leader” strategy to build customer loyalty to the store. (In fact, it appears that Quidsi was trying to follow that exact strategy itself.) While the questions did not directly lead to evidence of a violation under today’s law, it is possible that these hearings will lead to legislation to alter antitrust law’s current view of such aggressive pricing.

“Bullying” Competitors and Suppliers

Finally, Bezos was asked several times in several ways about Amazon’s treatment of its “partners,” both the manufacturers and third-party retailers who sell to consumers on its marketplace as well as manufacturers who sell directly to Amazon. Many of the questions included quotes from anonymous third parties who felt a need to be on Amazon: “have to work with them,” “we’re stuck,” “nowhere else to go.”

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Iatrogenics, the Sad Tale of Dr. Ignaz Semmelweis, and Antitrust Lawyers

July 26, 2020 | Bona Law PC

Author: Jarod Bona

I bet your first question is “What is iatrogenics?”

Have you ever gone to the doctor for something minor, only to take the prescribed medication and suffer through side effects that are worse than the initial ailment?

Iatrogenics is your net loss in welfare from the doctor. Iatros means healer in Greek. Iatrogenics is the loss caused by the healer.

The Hippocratic Oath, of course, is “first do no harm.” But it doesn’t always work out that way.

This term came up in my re-reading of Antifragile by Nassim Taleb. This is one of my favorite books of all time and I highly recommend that you read it, along with everything else that Taleb writes. And not just because we both advocate for deadlifts.

If you are a fan of Nassim Taleb, you might enjoy our article on Antitrust, Antifragility, Blockchain, and the Departement of Justice.

Dr. Ignaz Semmelweis

Taleb, in Antifragile, tells the story of Austro-Hungarian doctor Ignaz Semmelweis.

In the early to mid-1800’s, treatment by doctors wasn’t, according to Taleb, a net positive—going to the doctor actually increased your chance of death. This is iatrogenics—the healer, if you net the positive and negative, wasn’t good for your health.

Dr. Semmelweis noticed that women giving birth were substantially more likely to die of childbed fever if they were treated by doctors than if they were treated by mid-wives. Semmelweis didn’t figure out exactly why this was, but he did discover that if doctors cleaned their hands and medical instruments with a strong disinfectant, the rate of childbed fever dropped dramatically. The deaths, of course, were coming from the hospital.

You might think that the next part of the story is that people hailed Dr. Semmelweis a hero and the rate of women dying in childbirth fell dramatically from that point in time. Maybe there was a parade.

Sadly, no.

Dr. Semmelweis’s approach worked, but it wasn’t a theory developed by the “experts” and implicit, well, explicit, in his discovery of the disparity in deaths between doctor-treated patients and mid-wife-treated patients was the idea that doctors were harming their patients—killing them, in fact.

Dr. Semmelweis apparently wasn’t polite and passive in his criticism; Taleb points out that Semmelweis, for example, called the doctors “a bunch of criminals.” Semmelweis’s ideas contradicted the conventional wisdom and the people that could change the policy probably didn’t like him. Semmelweis tried to convince doctors and relevant policy makers to change, but they wouldn’t.

This led to despair and depression for Ignaz Semmelweis. And he ended up in an asylum where he died of a hospital fever, in sad irony.

Innovation in Ideas

The lessons from this story are plentiful. Obviously, doctors should wash their hands. And this, of course, is a good example of an iatrogenic situation. But, just as significantly, we must understand that our assumptions and the “experts” are sometimes wrong. And it is critical that we don’t shut out ideas that grow from the bottom up that question the experts, who force their ideas from the top down.

For example, when certain social media websites decided to hide or warn against any information relating to Coronavirus that contradicted the World Health Organization dictates, they created major systematic risks and the potential for situations like that of Dr. Semmelweis’s warnings about washing hands and killing pregnant women. Mandating information flow from the top-down creates a dogma that eliminates the possibility of bottom-up innovation and insights that can improve humanity.

Indeed, the World Health Organization, like many “experts,” and others were wrong, many times over. Wrong isn’t necessarily bad—we can learn from wrong. But forcing a specific perspective or truth on everyone, even if it is the conventional wisdom and or a widespread belief, freezes the current state of science and thinking wherever it is, instead of allowing it to prosper, grow, and progress.

The idea that science uncovers facts is true, but only for a static moment. By contrast, time is dynamic and “facts” change with it.

Think back 20 years, 40 years, 100 years, or 1000 years to what was conventional wisdom and how wrong it was. Also think back to the groups and hierarchies that tried to lock-in those ideas—which at the time were widespread and thought of as the truth or as facts. Think about Galileo.

The foundation of federal antitrust law is that “The heart of our national economy long has been faith in the value of competition.” Allowing competition creates opportunity, from the bottom up, for innovation, along with high quality and low prices, to prosper.

The same is true of ideas. If we create monopolies for ideas, even if they are considered established facts, the quality of our ideas and society will diminish. Innovation will stagnate. The experts are often wrong—let’s not follow them off the cliff, or more accurately, let’s not let them talk us off a cliff while they sit on their perch without skin in the game, preaching.

Iatrogenics Outside of Medicine

Back to Iatrogenics.

A problem that Taleb identifies is that, although mostly discussed in the context of medicine, iatrogenics is not limited to that field. Professionals and others of all walks of like sometimes create more harm than good.

In Antifragile, Taleb includes a handy table that shows interventions of various fields and the resulting iatrogenics/costs. For example—here is something that hits home in California: In Ecology, micromanaging away from forest fires can worsen total risks, by creating larger “big ones.”

Economics is an obvious example where intervention can cause harm—even intervention that appears “good” on the outside. You may agree or disagree, but Taleb cites manipulation of the business cycle, i.e. trying to make the ups and downs disappear, as a major source of fragility, which will lead to deeper crises when they happen.

Taleb cites several examples and they are interesting and persuasive, but he unfortunately leaves out your favorite profession—the antitrust attorney.

Let’s talk about the iatrogenics of antitrust attorneys.

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Can My Farm Cooperative Impose Production Restraints During Covid-19 Without Violating the Antitrust Laws?

July 23, 2020 | Bona Law PC

Author: Aaron Gott and Nick McNamara

As the effects of the ongoing COVID-19 pandemic continue to ripple across all sectors of the economy, agriculture has been hit especially hard. The widespread closure of restaurants combined with the general hit on most Americans’ wallets has precipitated a massive demand shock, which in turn has sent the prices of agricultural products such as corn, soybeans, milk, and fresh produce tumbling. While this may be good news for consumers (at least in the short run), it does not bode so well for farmers, who in recent months have had to resort to dumping milk and culling herds of livestock—practices which are both wasteful and potentially environmentally harmful.

Can farmers work together to mitigate these issues by agreeing, prior to production, to set production caps so that prices may be stabilized, and waste avoided? The answer depends on whether such controls on output are covered by the Capper-Volstead Act’s antitrust exemption for farm cooperatives.

Under normal circumstances, a concerted agreement among horizontal competitors to restrict output is a per se violation of Section 1 of the Sherman Act. But the Capper-Volstead Act, enacted in 1922 amid populist fervor in the agricultural sector, provides a limited antitrust exemption to “[p]ersons engaged in the production of agricultural products as farmers, planters, ranchmen, dairymen, nut or fruit growers.”

You can read a more detailed primer on the Capper-Volstead Act here. But, in brief, the act allows agricultural producers to collectively process, prepare, handle, and market their products. Now, it is important to note again that the exemption applies only to agricultural producers, not processors. This past year, there has been a flurry of antitrust litigation against pork and beef processors who are alleged to have agreed to restrict output, among other things. As discussed in the primer, the Supreme Court has held that a cooperative cannot include processors because they do not fit into the category of “farmers, planters, ranchmen, dairymen, nut or fruit growers.” Thus, only those entities at the most basic level of the food supply chain get to enjoy the exemption.

For producers, the farm cooperative exemption has been interpreted by courts to include a blanket exemption from antitrust liability for price fixing, a practice which also normally incurs per se liability under Section 1 of the Sherman Act. No court has ever directly ruled on the question of whether the exemption applies also to output controls, but there are indications they might find output restrictions outside the narrow confines of the act.

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The Early History of AGICOA: Fighting Over Cable Television and Competition Law in Belgium

July 15, 2020 | Bona Law PC

Author: Steven Madoff

If you are an in-house counsel, your company colleagues may, unfortunately, think of your group as the “business interference” department. But, if you are lucky, an opportunity to create a profit-center for your company may present itself. You just have to recognize it.

Early in my entertainment-law career, we were fortunate to see one of these rare opportunities. This is that story.

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Invited to Your First Trade Association Meeting? Here Are Important Antitrust Tips

July 9, 2020 | Bona Law PC

Author: Steven Cernak

So you have been invited to your first trade association meeting. Sounds like fun, right? You get a chance to mix and mingle with others in your industry, maybe swap notes with your counterparts at competitors who face the same pressures you do. What could go wrong?

A lot, from an antitrust perspective. While trade associations can provide tremendous benefits to members, by definition, they are meetings among competitors. Communication with competitors can lead to “agreements,” whether explicit handshakes or implicit winks and nods. And some of those agreements, like most related to competitive pricing, are automatically illegal and subject to severe penalties for both you and the company. Here, antitrust law follows Adam Smith’s admonition that

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

So even if you remember your company’s training from when you joined years ago and know enough to spell “antitrust” without a hyphen, you still need to remember these tips.

Learn from others in your company

You might not be the first in your company to attend an association meeting. Contact your lawyer or boss to see if your company has rules or other guidance for attending them. Follow that guidance. Some companies even require such reporting before attending. Others in your company might know this particular association and have some suggestions on how to make your attendance both safe and productive for you and your company.

Antitrust policy?

If you need to vet the association, start by asking to see its antitrust policy. All associations of competitors should have one and should be willing and able to share it with you quickly. Most post it online. The policy should acknowledge the necessity to follow all applicable antitrust laws and briefly describe how the association does just that. Frankly, the details are not as important as the fact that the association has one and can quickly provide it. An association executive who responds to your request with “Anti what?” should set off alarm bells.

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The Republican-Democrat Duopoly: Harvard Business Review Authors Ask for More Competition in Politics

July 6, 2020 | Bona Law PC

Author: Jarod Bona

As antitrust attorneys, we advocate for competition in product and service markets. The US Supreme Court recognizes that “the heart of our national economy long as been faith in the value of competition,” and we agree.

But competition matters elsewhere too. We certainly see it in sports. You might notice that sport leagues strive to increase parity to make the league more competitive overall. So when your favorite NFL Football team creates twelve to sixteen sleepless nights for you one year, the league rewards it with a high draft pick the next year. And if your team wins more than it loses, the NFL scheduling gods will punish them the next year with a tougher path to the playoffs.

Anyway, if you read the Harvard Business Review, you may have noticed an article that is sure to pique the interest of an antitrust lawyer like myself. (July-August 2020 Issue). It isn’t about sports, but it is still interesting.

Katherine M. Gehl and Michael E. Porter wrote “Fixing U.S. Politics: What business can—and must—do to revitalize democracy.”

Everyone seems unhappy with the current state of political affairs—so maybe more competition is the solution?

(This is a good reminder that every profession—including antitrust attorney—sees solutions to problems through their own, very specific, eyes. Knee injury? You need more competition. Of course, it isn’t always effective.)

Before we jump into Gehl and Porter’s work, as a disclaimer, Bona Law isn’t a political law firm: we don’t take any specific positions on politics or candidates. Our firm is made up of actual people, all of whom have freedom of thought and their own individual views, which we respect. As a firm, we take positions on certain types of policy—like encouraging competition and discouraging the government from destroying competition. But Bona Law is an antitrust law firm, so that’s not a surprise. But when it comes to politics, that is for each person to decide for themselves. Politics is personal.

According to the authors, politics are driven by the same five forces that affect more traditional markets: “the nature and intensity of rivalry, the power of buyers, the power of suppliers, the threat of new entrants, and the pressure from substitutes that compete in new ways.” (117). The authors explain that—unfortunately—the politics industry doesn’t have healthy competition.

The key problem, according to the authors, is that the Democrats and Republicans have a duopoly and that they work hard to keep it that way—with great success.

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Antitrust in Distribution and Franchising from Bona Law’s Steve Cernak Now Available

June 15, 2020 | Bona Law PC

Contrary to the belief of many of today’s businesspeople, antitrust law’s coverage of distribution did not start with Amazon or even the Internet. For decades, manufacturers have sold their products to resellers of all types to increase the distribution of their products. Manufacturers always have been interested in how their products, often with their brands, are resold. They often have tried to dictate or influence the pricing and marketing tactics of their resellers.

Since 1890, US federal antitrust law has been there every step of the way, drawing the line between permissible and impermissible restraints. The 2020 edition of Cernak’s Antitrust in Distribution and Franchising summarizes where those lines are today.

In just over one hundred pages, the book provides concise, plain English coverage of all the antitrust topics manufacturers and retailers—and their representatives—need to understand. Businesspeople can quickly get up to speed on potential distribution options. Libraries can provide their users, especially students, an efficient way to start their research. Generalist lawyers can review summaries of the key principles and cases necessary to assist their clients.

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California Rarely Enforces Non-Compete Clauses Against its Residents and Sometimes Won’t Even Enforce Out-of-State Forum Selection and Choice-of-Law Clauses

June 15, 2020 | Bona Law PC

Author: Luis Blanquez

California’s long-standing public policy in favor of employee mobility over an employer’s ability to prohibit any worker from going to work for a competitor is included in California Business & Professions Code Section 16600. So how do employers outside of California try to get around this powerful public policy?

First, employers in states where non-competes are still enforceable have attempted to implement choice-of-law clauses in employment agreements with California employees––requiring disputes between the parties to be governed not by California law, but rather by the law of a state more favorable to the enforcement of non-competes. But, as a general rule, California courts refuse to enforce such clauses. This is because California courts will not apply the law of another state where that law is “contrary to a fundamental public policy of the State of California.” In this case, the fundamental policy is open competition and employment mobility.

Conflict-of-law rules vary from state to state. Most states will not enforce a choice-of-law provision that violates the public policy of a state with a “materially greater interest” in the dispute or where the parties enjoy a “substantial relationship” with such state––i.e. where (i) the employee performs his/her work, (ii) the employee’s residence is, (iii) the contract was negotiated and formed, or (iv) the headquarters of the company is, among other factors.

Second, an employment agreement may also include a forum selection clause. In most cases it’s the employer––who sees one of its key employees leave to work for a competitor––who brings the case in the state court of the choice-of-law clause. When that happens, there is not much an employee can do, unless the case is moved to federal court and then transferred to another state. And even then, unless the case ends up in California federal court, the employee will have to rely on the courts of that other state to apply California choice-of-law principles to find the non-compete provision invalid.

To avoid such a hostile scenario, employees in California try to engage in what is called a “race to the courthouse.” They do so in the hope to effectively void their non-compete agreements under California law, before their former employers outside California enforce the non-compete agreement in a different state. This strategy sometimes works, but not always. For instance, the California Supreme Court has held that while California has a strong public policy against enforcing non-competition agreements, it’s not so strong as to warrant enjoining an employer from seeking relief in another state.

In any event, employers outside California have systematically struggled to enforce non-compete agreements in the past. And now it is even more complicated for them. For agreements entered into after January 1, 2017, California Labor Code Section 925 clarifies that employers may not require employees––who primarily work and reside in California––to agree to forum-selection and choice-of-law clauses that select non-California forums and/or laws, unless such employee is “individually represented by legal counsel in negotiating the terms of an agreement.”

RESTRICTIVE COVENANTS

Usually the way employers try to restrict their workers from going to work for a competitor is by including in the employment contract a so-called “restrictive covenant.”

A restrictive covenant is an agreement between an employer and employee that limits an employee’s ability to compete after leaving the employer. The most common and restrictive type of agreement is a non-compete agreement. It prohibits the employee from offering its services within the agreement’s geographic scope for a period of time after leaving the employer. Other types of restrictive covenants may also limit an employee’s ability to solicit the employer’s customers or employees for a period of time.

They are, unquestionably, restraints on trade. But are they unreasonable restraints on trade? In many states outside California that is the issue—if they are reasonable, a court will enforce them. And what does reasonable mean? Again, it depends. But typically, like other restraints on trade, they must usually be narrowly tailored to serve their purpose. They should contain “reasonable” limitations as to time, geographic area, and scope of activity. The laws, of course, vary from state to state. But as a practical matter, most judges are skeptical. Some courts will actually rewrite the agreements to make them reasonable.

Is My Restrictive Covenant Legal Under California Law?

In California, however, the law does not allow employers to enforce a restrictive covenant against their former employees, particularly when it takes the form of a non-compete agreement.

NON-COMPETE CLAUSES

These clauses usually have two primary purposes.

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