In the recent case of ‘Ixchel Pharma v. Biogen’, the Ninth Circuit asked the California Supreme Court to resolve two questions “because of their significance for business torts in California.”
May 15, 2020
By Dylan W. Wiseman and Julian “Pete” Mack
The U.S. Court of Appeals for the Ninth Circuit—which includes California—occasionally encounters questions of California law that it cannot resolve. When that happens, the Ninth Circuit can “certify” the question to the California Supreme Court—asking the California Court to determine the boundaries of California law. The Ninth Circuit then accepts the decision of the California Supreme Court, which is binding in both the federal courts of the Ninth Circuit and California state courts. The federal court reserves certification for significant issues, including those with important public policy ramifications, that have not been resolved by the California courts—it is not used for “run of the mill” cases.
In the recent case of Ixchel Pharma v. Biogen, 930 F.3d 1031 (2019), the Ninth Circuit asked the California Supreme Court to resolve two questions “because of their significance for business torts in California”:
Does California’s ban on non-compete agreements, Business & Professions Code §16600, apply only to contracts between employers and employees, or does it also apply to contracts between two businesses?
Does the requirement that a plaintiff plead an independently wrongful act to state a claim for intentional interference with an at-will employment contract apply to contracts outside the employment context?
The answers to these questions will have important and long-standing effects on business tort law in California, and the balance between two important areas of public policy: protecting the rights of employees and businesses to engage in open competition, and preserving contractual rights. The matter may be set for hearing as early as the California Supreme Court’s May calendar. A decision can be expected within approximately 90 days after the hearing.
Plaintiff Ixchel Pharma (Ixchel) is a biotechnology company. In 2016, Ixchel entered into a Collaboration Agreement with Forward Pharma (Forward), another biotech company, to develop products to treat degenerative nerve diseases using the chemical dimethyl fumarate, or DMF. Under the agreement, Ixchel and Forward would work together to develop a new DMF drug. Forward was responsible for conducting and paying for clinical trials, seeking FDA approval, and managing and paying for manufacturing and commercialization of the DMF drug; Ixchel would receive royalties from the sale of the new drug. The Collaboration Agreement was terminable by written notice, effective 60 days after notice was received.
In 2017, Forward entered into an Agreement with Biogen, another pharmaceutical company, to settle a longstanding intellectual property dispute. In the Forward/Biogen Agreement, Biogen agreed to pay Forward $1.25 billion and Forward agreed to stop working with Ixchel to develop a DMF drug. Forward specifically agreed to terminate all existing contracts, and not enter into any new contracts, with Ixchel regarding development of DMF drugs.
According to Ixchel, Biogen determined that Ixchel’s development of the new DMF drug would threaten Biogen’s sales of its own DMF drug designed to treat multiple sclerosis, and Biogen therefore induced Forward to breach its Development Agreement with Ixchel. Ixchel brought suit against Biogen (but not Forward) in federal district court for, among other things, antitrust violations of the federal Sherman Act and the California Cartwright Act, intentional and negligent interference with prospective business advantage, tortious interference with contract, and violations of California’s Unfair Competition Law, Business & Professions Code §17200, et seq. In its Second Amended Complaint, Ixchel added a claim that Biogen violated Business & Professions Code §16600, contending that the Forward/ Biogen Agreement wrongfully restrained Forward from engaging in lawful business with Ixchel and therefore was void.
When the federal district court dismissed its claims, Ixchel appealed to the Ninth Circuit. The appeals court found there were two important questions of California law that had not been decided by the California courts which would determine the outcome of the case, and certified the following questions to the California Supreme Court:
Does §16600 of the California Business and Professions Code void a contract by which a business is restrained from engaging in a lawful trade or business with another business?
Is a plaintiff required to plead an independently wrongful act in order to state a claim for intentional interference with a contract that can be terminated by a party at any time, or does that requirement apply only to at-will employment contracts?
Business & Professions Code §16600
The policy supporting Business & Professions Code §16600 distinguishes California from many other states. Business & Professions Code §16600 states: “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”
As interpreted by the California Supreme Court, §16600 provides a broad right for individuals “to pursue any lawful employment and enterprise of their choice,” and “an employer cannot by contract restrain a former employee from engaging in his or her profession, trade, or business unless the agreement falls within one of the exceptions to the rule.” Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937, 946-47. Indeed, in Edwards, the California Supreme Court rejected the Ninth Circuit’s “narrow restraint” exception to §16600, which held there was an exception for agreements that barred an individual “from pursuing only a small or limited part of the business, trade or profession.” The California Supreme Court has not previously decided, however, whether §16600 applies to contracts between two businesses, or only to contracts between employers and employees.
In its briefing before the California Supreme Court, Ixchel has taken the position that the statutory language is unambiguous and contains no limitation to individuals. Ixchel argues that, under Edwards, the public policy enunciated in the statute should be applied broadly to bar contracts restraining a business from engaging in lawful business activities.
Biogen concedes that §16600 can be applied to agreements between businesses. It argues, however, that because “[e]very agreement concerning trade … restrains” (Chicago Board of Trade v. United States, 246 U.S. 231, 238 (1918); In re Cipro Cases I & II, 61 Cal.4th 116, 146 (2015)), the “rule of reason” applied in antitrust cases should be applied to §16600. The California Supreme Court recently summarized the rule of reason as an inquiry into “whether the challenged conduct promotes or suppresses competition.” (In re Cipro Cases I & II, 61 Cal.4th at 146.)
Biogen urges that substantial harm will occur to numerous well-accepted forms of business agreements, with resulting disruption to both legal and economic relations, if Business and Professions Code §16600 is applied to agreements between businesses. As noted by the Ninth Circuit, if §16600 is applied to hold that “all agreements restraining trade are void, regardless of their procompetitive or limited nature, then every joint venture, lease, distribution agreement, license agreement and many other widely used business agreements that fall under California law would be at substantial risk of invalidation under §16600.” (Ixchel Pharma v. Biogen, 930 F.3d 1031, 1037 (2019)). Commonplace agreements such as a Ford dealership’s agreement to sell only vehicles made by Ford Motor Co., or software licensing agreements, could come under attack. Notwithstanding the importance of open competition, adoption of Ixchel’s reading of the statute would result in substantial uncertainty and economic harm, as the enforceability of long-accepted forms of business agreements will be placed in doubt.
The California Supreme Court’s ruling may have sweeping implications on contracts between businesses. We anticipate that the California Supreme Court will conduct a lengthy historical review of §16600 and California’s public policy around employee mobility. We anticipate the California Supreme Court will side with Biogen and conclude that a rigid application of §16600 would undermine contractual transactions between businesses. We expect that the California Supreme Court will acknowledge that prior cases applied §16600 between businesses to protect and promote employee mobility, and not for anti-trust concerns. Doing so will enable the California Supreme Court to articulate a rule that §16600 can apply between businesses where employee mobility concerns are implicated, but stop short of concluding that §16600 applies to all agreements.
We also expect the California Supreme Court to conclude that if a contract rises to the level of being an anti-trust violation, litigants should assert existing anti-trust theories and remedies. The ramifications of applying §16600 to invalidate commonplace business contracts could be catastrophic to the stability of California’s economy.
Intentional Interference With At-Will Agreements
California’s courts draw an important distinction between claims of interfering with a contract compared to interfering with a mere expectation of continued business. For a claim for intentional interference with a contract, a plaintiff must plead and prove (1) the existence of a valid contract between the plaintiff and a third party; (2) the defendant’s knowledge of that contract; (3) the defendant’s intentional acts designed to induce a breach or disruption of the contractual relationship; (4) actual breach or disruption of the contractual relationship; and (5) resulting damage. Pacific Gas & Electric Co. v. Bear Stearns & Co., 50 Cal.3d 1118, 1126 (1990).
In contrast, to state a claim for interference with a prospective relationship that has not been formalized into a contract, a further element is required: Plaintiff must also show that the defendant engaged in an independently wrongful act, i.e., an act “proscribed by some constitutional, statutory, regulatory, common law, or other determinable legal standard,” in order to state a claim. Korea Supply Co. v. Lockheed Martin, 29 Cal.4th 1134, 1159 (2003)).
Historically, the California courts have held that the tort of interference with contractual relations may be predicated upon interference with an at-will contract. A third party’s “interference with an at-will contract is actionable interference with the contractual relationship” because the contractual relationship is at the will of the parties, not at the will of outsiders. Pacific Gas & Electric Co. v. Bear Stearns & Co., 50 Cal.3d at 1127.
In 2004, however, a unanimous California Supreme Court decided that to state a claim for intentional interference with an at-will employment contract, a plaintiff must plead an independently wrongful act “that induced an at-will employee to leave the plaintiff.” Reeves v. Hanlon, 33 Cal. 4th 1140, 1152-53 (2004). The court’s determination was based on a number of public policy considerations. First, the court held that “[w]here no unlawful methods are used, public policy generally supports a competitor’s right to offer more pay or better terms to another’s employee, so long as the employee is free to leave.” Id. at 1151. Second, “[t]he interests of the employee in his own mobility and betterment are deemed paramount to the competitive business interests of the employers, where neither the employee nor his new employer has committed any illegal act accompanying the employment change.” Id.
Third, the Supreme Court reasoned that the economic relationship between parties to contracts that are terminable at will is distinguishable from that between parties to other contracts. While an ordinary contract is generally “deemed worthy of protection from interference by a stranger to the agreement,” in circumstances where “a party to a contract with the plaintiff is free to terminate the contractual relationships when he chooses,” then “any interference with it that induces its termination is primarily an interference with the future relationships between the parties, and the plaintiff has no legal assurance of them.” Id. Because “an interference as such is primarily an interference with the future relationships between the contracting parties,” Reeves v. Hanlon, 33 Cal. 4th 1140 (2004), held that the standard applicable to claims for intentional interference with prospective economic advantage applied, meaning that a plaintiff must plead and prove that the defendant engaged in an independently wrongful act that caused the at-will employee to leave his or her employment. Id. at 1152-53.
Here, Ixchel argues that Pacific Gas & Electric Co. v. Bear Stearns is the law, and that Reeves is limited to the employer/employee context. Biogen argues that the policy underlying Reeves-enabling parties to an at-will contract to receive superior terms from outsiders is not confined to employment agreements. Rather, Biogen contends that a claim for intentional interference with contract should not require pleading an independently wrongful act when the defendant, in seeking a relationship with a third party, induces that third party to terminate its at-will contract with the plaintiff.
It seems unlikely that the California Supreme Court will extend Reeves beyond employer-employee contracts. Reeves emphasized the rights of employees, finding that applying the tort standard of interference with prospective business advantage in the context of soliciting at-will employees was “particularly appropriate.” Reeves, 33 Cal. 4th at 1145. The court reasoned that adding the additional element of an independently wrongful act would “promote the public policies supporting the right of at-will employees to pursue opportunities for economic benefit and the right of employers to compete for talented workers.”
Public policy further protects parties’ contractual rights. As the California Supreme Court stated in Bear Stearns, “the expectation that the parties will honor the terms of the contract is protected against officious intermeddlers.” Pacific Gas & Electric Co. v. Bear Stearns & Co., 50 Cal.3d at 1128. Adding the “independently wrongful conduct” element to interference with contract claims disregards the importance of the contract relationship compared to just a mere expectancy of continued business. As a result, those businesses with valid, enforceable contracts could find themselves with an extra element to prove. Adding the “independently wrongful conduct” standard to interference with contract claims will also act to destabilize California’s economy by enabling “officious intermeddlers” more leeway to obstruct or hinder valid contracts.
Dylan Wiseman is the Co-Chair of Buchalter’s Trade Secret and Employee Mobility Practice Group. His practice focuses on intellectual property protection, including representing employers in cases involving trade secrets, unfair competition, employee mobility disputes, cloud-based data theft and more.
Julian “Pete” Mack, Of Counsel at Buchalter specializes in trade secret, unfair competition, and employee retention and recruitment matters, business and commercial litigation, and financial institutions, estate and trust litigation. His practice includes complex contractual, banking and probate matters, with substantial experience in creditors’ rights, lender liability, bank fraud, and financial elder abuse litigation.