The opinion
Filed 8/20/24
CERTIFIED FOR PUBLICATION
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
FOURTH APPELLATE DISTRICT
DIVISION THREE
ROBERT S. SAMUELIAN et al.,
Plaintiffs and Respondents, G061911, G062416 & G062426
v. (Super. Ct. No. 30-2021-
01194619)
LIFE GENERATIONS
HEALTHCARE, LLC, et al., OPINION
Defendants and Appellants.
Appeal from a judgment of the Superior Court of Orange County,
Layne H. Melzer, Judge. Reversed.
Horvitz & Levy, Robert H. Wright, Melissa B. Whalen and
Jeremy B. Rosen; Wilson, Elser, Moskowitz, Edelman & Dicker and Gary S.
Pancer; Law Offices of Kevin E. Monson, Kevin E. Monson and David A.
Sprowl for Defendant and Appellant Life Generations Healthcare.
Doll Amir Eley, Michael Amir, Mary Glarum, Brett Oberst;
Greines, Martin, Stein & Richland, Timothy Coates, Jeffrey E. Raskin;
Tantalo & Adler, Joel M. Tantalo, Michael S. Adler; Murchison & Cumming,
William Naeve and Nancy J. DePasquale for Defendants and Appellants.
Payne & Fears, Daniel L. Rasmussen, Benjamin A. Nix; Gibson,
Dunn & Crutcher, Blaine H. Evanson and Matt Aidan Getz for Plaintiffs and
Respondents.
* * *
Absent an applicable exception, “every contract by which anyone
is restrained from engaging in a lawful profession, trade, or business of any
1
kind is to that extent void.” (Bus. & Prof. Code, § 16600, subd. (a).) Our
Supreme Court recently clarified in Ixchel Pharma, LLC v. Biogen, Inc.
(2020) 9 Cal.5th 1130, 1159 (Ixchel) that one of two standards applies to
determine whether noncompetition agreements are void under section 16600.
Restraints are either void per se (the per se standard) or evaluated under a
reasonableness test (the reasonableness standard). The former standard
applies to restraints arising from “termination of employment or the sale of
interest in a business,” while the latter applies to “agreements limiting
commercial dealings and business operations.” (Ixchel, at p. 1152.) We are not
aware of any authority addressing the applicable standard to cases outside
these categories.
This case involves a noncompetition restraint following the sale
of a portion of a business interest. Respondents Robert and Stephen
2
Samuelian (collectively, the Samuelians) co-founded appellant Life
Generations Healthcare, LLC (the Company) along with appellant Thomas
Olds, Jr. Initially, the Samuelians owned nearly half the Company together.
They later sold a portion of this interest. In connection with this partial sale,
1
All further undesignated statutory references are to the
Business and Professions Code.
2
We refer to the Samuelians individually by their first names.
2
the Company adopted a new operating agreement that restrained its
members, including the Samuelians, from competing with the Company.
The Samuelians later filed a dispute in arbitration challenging
the enforceability of this noncompetition provision. The arbitrator found the
provision arose from the sale of a business interest. As such, he concluded it
was invalid per se and rejected the Company’s argument for application of
the reasonableness standard under Ixchel. However, prior to the arbitration,
the parties had signed an agreement barring the arbitrator from making any
errors of law. So, when the Samuelians later petitioned for confirmation of
the arbitration award, the Company argued the arbitrator had legally erred
by applying the per se standard. The trial court reviewed the arbitrator’s
ruling de novo, found no error, and confirmed the award.
On appeal, the Company admits that under Ixchel and other
precedent, the per se standard applies to noncompetition restraints arising
from the sale of an entire business interest. But it argues no case has held
that the per se standard applies to restraints arising from the sale of a
partial business interest, as is the case here. It asserts the reasonableness
standard should apply in such cases.
After reviewing relevant Supreme Court authority and public
policy, we agree with the Company. No case has addressed this issue, and
nothing in the policy behind section 16600 calls for application of the per se
standard to partial sales. A sale of a partial business interest differs
drastically from the sale of an entire business interest. Following a partial
sale, the seller remains an owner of the company and may still exercise some
degree of control over its operations. Given this context, a noncompetition
provision arising from a partial sale cannot be deemed inherently
anticompetitive and invalidated per se under section 16600. Rather, it must
3
be scrutinized under the reasonableness standard to determine whether it
has procompetitive benefits given the nature of the selling owner’s continuing
connection to the business.
Due to our conclusion that the arbitrator applied the wrong
standard under section 16600, we do not address the other arguments raised
by Olds and the other appellants concerning purported errors that occurred
later in the arbitration. The trial court’s judgment confirming the arbitrator’s
award is reversed.
FACTS AND PROCEDURAL HISTORY
I.
THE COMPANY
The Company operates numerous skilled nursing and related
healthcare facilities in California and Nevada. It was founded by the
Samuelians and Olds in 1998. The Company was initially formed as a limited
liability company but incorporated a year later
Following incorporation, the Samuelians owned a combined 49.4
percent of the Company, with Steven owning 31.3 percent and Robert owing
18.1 percent. The other owners were appellants Olds (34.7 percent), Fred
Smith (5.7 percent) and Lois Mastrocola (4 percent), and nonparties Mark
Howlett (4.8 percent), and Paul Haider (1.4 percent).3 The Samuelians and
Olds were on the Company’s board of directors, and Robert was its general
counsel.
Tensions allegedly arose over the years between Olds and the
Samuelians over the Company’s direction. In 2007, the parties agreed to a
3
All ownership percentages have been rounded to the nearest
tenth.
4
partial buyout of the Samuelians’ interest in the Company and to reorganize
the Company from a corporation back to a limited liability company.
On October 25, 2007, the shareholders exchanged their shares in
the Company for ownership units in the reorganized limited liability
company. That same day, a new operating agreement for the Company (the
operating agreement) was entered into by its member—Olds, the Samuelians,
Howlett, Smith, Haider, and Mastrocola. The operating agreement specified
the Company would initially be managed by three managers, but the number
4
of managers could be changed over time. Olds and the Samuelians were
elected as the Company’s first managers. Olds was named president and
chief executive officer, and Mastrocola was named secretary and chief
financial officer. Mastrocola was later appointed as a manager in 2012.
A few days later, on October 29, the Company contracted to buy
nearly half of the Samuelians’ total interest for roughly $61 million. It also
agreed to purchase all of Howlett and Haider’s interest in the Company.
Following these buyouts, Olds owned 59.4 percent of the Company, Smith
owned 9.7 percent, Mastrocola owned 7 percent, and the Samuelians owned a
combined 23.9 percent (Steven owned 15.1 percent and Robert owned 8.8
percent).
That same day, Robert resigned from all the positions he held at
the Company except for general counsel and his membership in a special
committee (the LM Compensation Committee) holding approval rights over
4
Limited liability companies can be managed by members or by
managers. (Corp. Code, § 17704.07, subds. (b) & (c).) “A limited liability
company is a member-managed limited liability company unless the articles
of organization” specify it is to be managed by a manager. (Corp. Code,
§§ 17704.07, subd. (a), 17702.01, subd. (b)(5).)
5
the terms of Mastrocola’s employment, including her job duties,
compensation, benefits, and termination. Stephen also resigned from all
positions he held at the Company except for his membership in the LM
Compensation Committee. Despite these resignations, the Samuelians still
retained certain voting right as owners of the Company, which are described
below.
Under the operating agreement, the Samuelians would remain
members on the three-person LM Compensation Committee as long as they
were owners of the Company (the Chairman of the Board of Managers would
be the third member). Changes to the terms of Mastrocola’s employment
require approval from two members on the LM Compensation Committee, so
no changes to these terms could be made without consent from at least one of
the Samuelians.
Likewise, the operating agreement provides that as long as a
Samuelian remained an owner, consent from at least one of them was
required (1) for any amendments or changes to the operating agreement or
the Company’s articles of organization, (2) for any split, combination, or
reclassification of any membership interests, (3) for any transaction or
agreement between the Company and a unitholder, unitholder’s family
member, or entities affiliated with a unitholder or a unitholder’s family, (4) to
increase the number of ownership units that could be granted as options, and
(5) to engage the Company in a new line of business.
The operating agreement also requires the Company to provide
the Samuelians with (1) monthly financial statements (both audited and
unaudited), including balance sheets, income statements, and cash flow
statements, and (2) notices of any loan defaults or lawsuits filed against the
6
Company (or its subsidiaries) that could exceed its insurance coverage or
affect the value of its ownership units.
Section 6.4 of the operating agreement imposes fiduciary duties
on all the Company’s members, including the Samuelians (section 6.4).
Section 6.4(a) states, “The Unitholders acknowledge and agree that the
provisions of this Section 6.4 are expressions of their fiduciary duties
(including, without limitation, the duty of loyalty) to the Company as
Unitholders . . . .” Section 6.4(b) provides that “[n]o Unitholder or Manager
shall . . . Engage in the Business within the State of California except on
behalf of the Company” (the noncompetition provision). Section 6.4(e)(i)
requires “each Unitholder and Manager . . . to present to the Company any
opportunity to Engage in the Business in California that formally comes to
his or her attention in writing” (the corporate opportunities provision).
“Business” means, “(i) the ownership and/or operation of skilled nursing,
assisted living, Alzheimer disease and/or physical, occupational or speech
therapy facilities; (ii) the provision of nurse registry services; and (iii) the
ownership and/or operation of pharmacies and the provision of pharmacy
services.”
If a unitholder breaches section 6.4, the operating agreement
allows the Company to purchase “all or any portion” of the breaching party’s
units for fair market value after timely delivering written notice.
II.
THE ARBITRATION FILING
The Company allegedly discovered in April 2015 that the
Samuelians had breached the noncompetition and corporate opportunities
provisions. It purported to exercise its right under the operating agreement to
7
buy the Samuelians’ entire ownership interest. It sent them the required
notices and tendered two checks totaling about $19.5 million.
The Samuelians denied any wrongdoing and refused the checks.
But they were cut out of the Company and Smith, Mastrocola, and Olds
(collectively, the individual defendants) absorbed their ownership interests.
Thereafter, the Company did not pay the Samuelians any profit distributions
or obtain any required approvals from them, such as approval to increase
Mastrocola’s salary.
The Samuelians initiated an arbitration action against the
Company and Olds in June 2015 and later added Mastrocola and Smith as
defendants. The Samuelians sought declaratory relief concerning the validity
of the Company’s forced buyout, and they also alleged individual and
derivative claims against the Company and the individual defendants
(collectively, the defendants) for breach of contract, breach of fiduciary duty,
conversion, and fraud, among other claims.
The Company cross-complained against the Samuelians. It
alleged they had breached the noncompetition and corporate opportunities
provisions, and it also sought declaratory relief as to the buyout’s validity.
The arbitration was initially filed with the American Arbitration
Association, but the parties entered a written agreement (the transfer
agreement) transferring the arbitration action to Judicate West and selecting
Judge Stuart Waldrip (Ret.) as their arbitrator. The transfer agreement also
expressly limits the arbitrator’s power: “The Arbitrator shall not have the
power to commit errors of law or legal reasoning and the award may be
vacated or corrected on appeal to a court of competent jurisdiction for any
such error.”
8
The arbitration was trifurcated into three phases. Phase One
focused on the whether the Company could enforce the noncompetition and
corporate opportunities provisions against the Samuelians. Phase Two
covered the Samuelians’ claims for breach of contract, breach of fiduciary
duty, and conversion against the individual defendants. Phase Three
involved the Samuelians’ direct claims for damages against the Company and
their derivative claims asserted on the Company’s behalf.
III.
PHASE ONE
The arbitrator issued his Phase One rulings in May 2017. He
found the noncompetition and corporate opportunities provisions were
unenforceable. The noncompetition provision was a contractual restraint on
trade that was invalid per se under section 16600. Further, the Samuelians
owed no fiduciary duties to the Company because they were members in a
manager-managed limited liability company (manager-managed company).
He explained that under applicable law, fiduciary obligations are only
imposed on members in a member-managed limited liability company
(member-managed company) or managers in a manager-managed company.
The arbitrator also rejected defendants’ contention that the
noncompetition provision was valid under section 16601. This section
provides that “any owner of a business entity selling . . . all of his or her
ownership interest in the business entity . . . may agree with the buyer to
refrain from carrying on a similar business within a specified geographic area
in which the business so sold, . . . so long as the buyer . . . carries on a like
business therein.” (§ 16601, italics added.) The arbitrator found section 16601
did not apply because the Samuelians only sold part, not all, of their interest
during the Company’s reorganization in 2007. Further, the arbitrator noted
9
the noncompetition provision was invalid under section 16601 because it was
not reasonably limited in time or geographic scope.
Next, the arbitrator found the corporate opportunities provision
was invalid because it was intertwined with the noncompetition provision
and could not be severed from it. It also concluded this provision was “a
thinly disguised non-compete itself” because it placed “a significant restraint
on doing business by requiring presentation to the Company” of various
business opportunities.
Based on these findings, the arbitrator held the Company’s forced
buyout of the Samuelians was invalid. The Samuelians remained members in
the Company and, therefore, were entitled to all rights and privileges
afforded to them under the operating agreement.
Defendants later brought a motion for reconsideration of the
arbitrator’s Phase One rulings (the reconsideration motion) in September
2020, after Ixchel was decided.5 They argued the arbitrator’s ruling was
erroneous because it had applied the per se standard to the noncompetition
provision. They claimed the arbitrator must apply the reasonableness
standard under Ixchel.
The Samuelians objected to the reconsideration motion on
grounds it was untimely. The arbitrator overruled this objection and
exercised his discretion to hear the motion. But he denied it on grounds the
Phase One ruling did not conflict with Ixchel. In particular, the arbitrator
5
Defendants had previously moved for reconsideration following
Quidel Corp. v. Superior Court (2019) 39 Cal.App.5th 530, which also
interpreted section 16600. This motion was denied. The Supreme Court later
granted review of Quidel and ordered it to be vacated and reconsidered in
light of Ixchel. (Quidel Corp. v. Superior Court (2020) 57 Cal.App.5th 155.)
10
explained that Ixchel held the per se standard applies to noncompetition
provisions arising from “the sale of interest in a business.” (Quoting Ixchel,
supra, 9 Cal.5th at p. 1159.) He found the noncompetition provision arose
from the Samuelians’ 2007 sale of a portion of their interest in the Company.
Thus, he concluded the per se standard applied under Ixchel.
IV.
PHASE TWO
Due to our conclusion that the arbitrator’s Phase One rulings
were incorrect, we only briefly recite the history of Phase Two and Phase
Three.
The Samuelians demurred to the Company’s cross-complaint.
Based on his Phase One rulings, the arbitrator sustained the demurrer
without leave to amend as to all claims based on the noncompetition and
corporate opportunities provisions.
In Phase Two, the arbitrator noted that following their wrongful
ouster from the Company, the Samuelians received no distributions while the
individual defendants received millions of dollars. The arbitrator found the
individual defendants had wrongfully withheld distributions from the
Samuelians under three separate theories: conversion, breach of fiduciary
duty, and breach of contract. Specifically, he found all the individual
defendants were liable for conversion, while only Mastrocola and Olds were
liable for breach of contract and breach of fiduciary duty since they were
managers of the Company (Smith was not). The arbitrator explained the
Samuelians could only “recover under one of the three alternate theories” of
liability, with conversion being the primary theory of recovery and breach of
fiduciary duty and breach of contract providing alternative theories.
11
V.
PHASE THREE
In Phase Three, the arbitrator built on the findings of Phase One
and Phase Two to fashion a multilayered award for all the claims arising
from the Samuelians wrongful ouster from the Company and the resulting
unpaid distributions (the award). The award determined the Company owed
the Samuelians roughly $21.1 million in unpaid distributions (about $13.4
million to Steven and $7.7 million to Robert) plus interest. If the Company
paid this sum, it would not have to claw back distributions made to the
individual defendants, nor would the Samuelians be able to recover damages
for the unpaid distributions against the individual defendants under the
Phase Two ruling. The arbitrator explained this award was designed to
“make [the Company] the prime mover in rectifying the financial and
business relationships between the owners of the Company. The ‘backup
plan’ involve[d] clawing back funds from members who ha[d] received
disproportionate distributions.”
The award also found Mastrocola’s salary had been improperly
increased without the Samuelians’ approval. Thus, Mastrocola was ordered to
return the unapproved portion of her salary to the Company.
Finally, because the Samuelians were the prevailing parties in
the litigation, they were awarded about $5.7 million in reasonable attorney
fees and costs under the operating agreement.
VI.
TRIAL COURT
The Samuelians petitioned the trial court to confirm the award,
while the Company and the individual defendants filed separate petitions to
vacate or correct it. Following numerous briefs and hearings, the trial court
12
granted the Samuelians’ petition to confirm and denied both petitions to
vacate. It issued a statement of decision explaining its ruling.
To begin, the court explained the transfer agreement allowed it to
review the arbitrator’s award for legal error but not factual errors or abuses
of discretion.
As to the noncompetition provision’s validity, the court explained
that under Ixchel, noncompetition agreements tied to the sale of a business
interest are invalid per se. Here, the arbitrator had made an unreviewable
factual finding that the noncompetition provision arose from the sale of a
business interest. As such, the per se standard applied. The court also noted
that even if the arbitrator had applied the wrong standard, that error was not
prejudicial because the arbitrator had found the noncompetition provision
was unreasonable based on its temporal and geographic scope.
Likewise, the court found no legal error as to arbitrator’s finding
that the corporate opportunity provision was inseparable from the
noncompetition provision and “a ‘thinly disguised non-compete itself.’” Nor
did it find any legal errors with the arbitrator’s conclusion that the
Samuelians did not owe the Company “fiduciary duties, explaining that
under applicable law, fiduciary duties are only applicable to managers of a
manager-managed LLC [(like the Company)], and not minority members.”
Finally, the court concluded the arbitrator’s Phase Two and
Phase Three rulings contained no errors of law.
Judgment confirming the award was entered in August 2022. The
Company and the individual defendants filed separate appeals challenging
the court’s confirmation of the award, and they ask for the award to be
vacated. The Company’s appeal primarily focuses on the Phase One rulings.
It claims the arbitrator erred by applying the per se standard to the
13
noncompetition provision rather than the reasonableness standard. The
individual defendants’ appeal joins the Company’s argument as to the Phase
One rulings. They also contend the arbitrator made various legal errors in
Phase Two and Phase Three as to the claims for conversion, breach of
contract, breach of fiduciary duty, the claim concerning Mastrocola’s salary,
and the remedy.
We agree the arbitrator committed a prejudicial legal error in
Phase One. The rulings in Phase Two and Phase Three were based on the
Phase One ruling. Thus, the merits of the Phase Two and Phase Three
rulings cannot be separated from the erroneous Phase One ruling, and the
entire award must be vacated based on the errors in Phase One. (Code Civ.
Proc., § 1286.2, subd. (a)(4); VVA-TWO, LLC v. Impact Development Group,
LLC (2020) 48 Cal.App.5th 985, 998.)
DISCUSSION
I.
STANDARD OF REVIEW
A trial court’s order confirming an arbitration award is reviewed
de novo. (Greenspan v. LADT, LLC (2010) 185 Cal.App.4th 1413, 1435.)
Generally, however, arbitrators have broad authority and neither a trial
court nor an appellate court can vacate an arbitration award based on a legal
or factual error. (Moncharsh v. Heily & Blase (1992) 3 Cal.4th 1, 11.) The
parties can alter this general rule by “requiring a dispute to be decided
according to the rule of law, and mak[ing] plain their intention that the
award is reviewable for legal error.” (Cable Connection, Inc. v. DIRECTV, Inc.
(2008) 44 Cal.4th 1334, 1355 (Cable Connection).) “[T]o take themselves out
of the general rule that the merits of the award are not subject to judicial
14
review, the parties must clearly agree that legal errors are an excess of
arbitral authority that is reviewable by the courts.” (Id. at p. 1361.)
Here, the transfer agreement expressly allows for review of the
arbitrator’s legal rulings: “The Arbitrator shall not have the power to commit
errors of law or legal reasoning and the award may be vacated or corrected on
6
appeal to a court of competent jurisdiction for any such error.” As such, we
review the award de novo for errors of law. (Oakland-Alameda County
Coliseum Authority v. Golden State Warriors, LLC (2020) 53 Cal.App.5th 807,
816; see Connerly v. State Personnel Bd. (2006) 37 Cal.4th 1169, 1176
[questions of law are reviewed de novo].)
To obtain reversal, defendants must also show they were
prejudiced by any legal error. (Richey v. AutoNation, Inc. (2015) 60 Cal.4th
909, 920.) Prejudice means there is a reasonably probability defendants
would have received a more favorable result in the absence of the error.
(Cassim v. Allstate Ins. Co. (2004) 33 Cal.4th 780, 800.) “‘[A] “probability” in
this context does not mean more likely than not, but merely a reasonable
chance, more than an abstract possibility.’” (Ibid.)
II.
PHASE ONE ISSUES
The Company argues the arbitrator legally erred by applying the
per se standard to the noncompetition provision. It contends the
reasonableness standard applies. We agree.
6
The language from the transfer agreement appears to be pulled
directly from the contract at issue in Cable Connection. (Cable Connection,
supra, 44 Cal.4th at p. 1340.)
15
A. Forfeiture of the Argument
Before turning to the merits of the Company’s argument above,
we address the Samuelians’ contention that the Company forfeited it by
failing to timely raise it during the arbitration. The Company raised this
argument for the first time in the reconsideration motion, which was filed
during Phase Three. The Samuelians claim this argument should have been
made in Phase One.
We need not spend much time on the Samuelians’ forfeiture
argument, as the arbitrator rejected it during the arbitration. He ruled that
even if the Company’s argument for the reasonableness standard could have
been made earlier, “timeliness [was] not an issue” because he was exercising
his discretion to consider it. The trial court found it lacked authority to
review the arbitrator’s exercises of discretion. Neither party has argued this
conclusion was wrong, and we will not make the argument on the
Samuelians’ behalf. (See City of Riverside v. Horspool (2014) 223 Cal.App.4th
670, 679, fn. 8.) Thus, we will not review the arbitrator’s exercise of
discretion.
Besides, we would find no abuse of discretion even if we could
review the arbitrator’s ruling. The reconsideration motion was filed after
Ixchel. As described below, Ixchel provided a major clarification as to when
the per se and reasonableness standards should be applied to noncompetition
agreements. As such, it was not unreasonable for the arbitrator to reconsider
his Phase One rulings on the noncompetition provision in light of Ixchel. (See
In re Marriage of Barth (2012) 210 Cal.App.4th 363, 374 [“An abuse of
discretion is only demonstrated when no reasonable judge could have made
the challenged order”].)
16
B. The Per Se and Reasonableness Standards
During the time of the arbitration, former section 16600 stated:
“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.” (Former § 16600, added by Stats.1941, c. 526,
§ 1.) Section 16600 has since been amended, but the amendments are
7
immaterial to our analysis.
Under section 16600, noncompetition agreements are evaluated
under one of two standards: the per se standard or the reasonableness
standard. Under the per se standard, noncompetition restraints are invalid
per se “without regard to their reasonableness.” (Ixchel, supra, 9 Cal.5th at
p. 1152.) As for the reasonableness standard, courts examine “‘whether an
agreement harms competition more than it helps’ by considering ‘“the facts
peculiar to the business in which the restraint is applied, the nature of the
restraint and its effects, and the history of the restraint and the reasons for
its adoption.”’” (Id. at p. 1150.) These standards were most recently discussed
by the Supreme Court in Ixchel and Edwards v. Arthur Andersen LLP (2008)
44 Cal.4th 937 (Edwards).
In Edwards, supra, 44 Cal.4th 937, the plaintiff was required to
sign a noncompetition agreement as a condition of his employment with the
defendant. The noncompetition agreement generally barred the plaintiff, an
accountant, from working for or soliciting certain clients of the defendant
7
Effective January 1, 2024, section 16600 added subdivisions
clarifying it (1) applies broadly to void noncompetition agreements in the
employment context, and (2) it not limited to contracts where the person
being restrained is a party to the contract. (Now § 16600, subds. (b) & (c), as
amended by Stats. 2023, ch. 828, §1.) Former section 16600 has been
renumbered as subdivision (a).
17
following his termination. (Id. at p. 942.) The plaintiff later challenged the
agreement’s enforceability. (Id. at p. 943.)
Our Supreme Court concluded the noncompetition agreement
was invalid per se under section 16600. (Edwards, supra, 44 Cal.4th at pp.
947–948.) The Court observed, “[u]nder the common law, as is still true in
many states today, contractual restraints on the practice of a profession,
business, or trade, were considered valid, as long as they were reasonably
imposed.” (Id. at p. 945.) But the Legislature “rejected the common law ‘rule
of reasonableness,’” by enacting Civil Code section 1673, repealed by Statutes
1941, chapter 526, section 2, which was later replaced by former section
16600. (Ibid.) “In the years since its original enactment as Civil Code section
1673, our courts have consistently affirmed that section 16600 evinces a
settled legislative policy in favor of open competition and employee mobility.”
(Id. at p. 946.) “Under the statute’s plain meaning . . . 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.” (Id. at pp. 946–947.)
The court revisited section 16600 a few years later in Ixchel,
which involved a noncompetition agreement between two pharmaceutical
companies. The restrained party was barred from contracting with any third
party to develop products containing a certain active ingredient (dimethyl
fumarate). (Ixchel, supra, 9 Cal.5th at pp. 1138–1139.) This restraint was
later challenged. The Supreme Court addressed two issues in Ixchel. First, it
considered whether section 16600 applied outside the employment context to
noncompetition agreements between businesses. After concluding it did, the
Court next addressed whether such restraints were evaluated under the per
se or reasonableness standard. (Id. at pp. 1148–1149.)
18
In answering the second question, the Court reviewed its prior
decisions involving section 16600 and its predecessor, former Civil Code
section 1673. The Court concluded its prior decisions applied the per se
standard to “noncompetition agreements following the termination of
employment or sale of interest in a business.” (Ixchel, supra, 9 Cal.5th at p.
1159.) But it rejected the argument that “Edwards conclusively held that
section 16600 invalidates all restraints on trade for all contracts, no matter
how reasonable.” (Id. at p. 1158.) Rather, the Court observed its past
decisions had found contractual restraints on business operations and
commercial dealings to be valid if reasonable. (Id. at p. 1153.) It affirmed
these past decisions and held that “a reasonableness standard [applies] to
contractual restraints on business operations and commercials dealings.” (Id.
at p. 1159.)
The Court also explained that it was “mindful of the
consequences of strictly interpreting the language of section 16600 to
invalidate all contracts that limit the freedom to engage in commercial
dealing. ‘Every agreement concerning trade . . . restrains.’ [Citation.] In
certain circumstances, contractual limitations on the freedom to engage in
commercial dealings can promote competition.” (Ixchel, supra, 9 Cal.5th at p.
1160.) The Court noted the competitive benefits of exclusive dealing
arrangements between businesses. (Id. at pp. 1160–1161.) After highlighting
these potential benefits, the Court “decline[d] to construe section 16600 to”
facially invalidate “such arrangements . . . simply because they restrain trade
in some way.” (Id. at p. 1161.)
Here, the arbitrator found the per se standard applied for two
reasons. First, the noncompetition provision was “the product of the sale by
[the Samuelians] of a substantial interest (but not the entire interest) they
19
held in the [Company] for more than $60 million. . . . The strict [(i.e., per se)]
application of § 16600 was specifically approved by both [Ixchel] and Edwards
in cases of ‘sale of an interest in a business.’” “[T]he transaction resulting in
the [noncompetition provision] falls squarely within the long line of cases
upholding strict application of § 16600’s prohibition in sales of an interest in
a business.”
Second, the arbitrator believed section 16600 created a default
standard of per se invalidity for contractual provisions that restrain anyone
from “‘engaging [in] a lawful profession, trade, or business of any kind.’”
(Quoting § 16600.) And he read Ixchel as creating an exception to this general
rule “for business-to-business contracts that should actually promote
competition and the smooth flow of business and industry.” He concluded the
noncompetition provision completely restrained the Samuelians from
pursuing lawful employment or operating a business of their choice within
California and failed to promote competition. Thus, he concluded this case
was closer to the facts of Edwards than Ixchel and applied the per se
standard.
On appeal, the Company acknowledges Ixchel’s statements that
noncompetition agreements are invalid per se if they arise from the sale of a
business interest. (Ixchel, supra, 9 Cal.5th at p. 1159.) But it contends the per
se standard only applies if the restrained party sells its entire business
interest and “does not apply to partial sales after which an individual retains
a significant interest in a business.” It claims the reasonableness standard
applies in such cases.
20
8
We agree the reasonableness standard applies to partial sales.
We also find this case is closer to the facts of Ixchel than Edwards. As
explained below, the seller remains an owner of a business following a partial
sale and may hold some degree of control over its operations. Due to that
ongoing connection, noncompetition agreements arising from a partial sale
must be evaluated under the reasonableness standard to determine whether
they have procompetitive benefits.
C. The Applicable Standard
We begin by determining the applicable standard for partial
sales. Nothing in Ixchel or the cases cited therein hold that a noncompetition
agreement is invalid per se if it arises from the partial sale of a business
interest. Ixchel did not involve this issue. Rather, in surveying its prior
opinions interpreting section 16600, the Supreme Court explained that
“[o]ver time, our case law has generally invalidated agreements not to
compete upon the termination of employment or upon the sale of interest in a
business without inquiring into their reasonableness . . . .” (Ixchel, supra, 9
Cal.5th at p. 1151.) After reviewing these cases in detail, it determined they
were still good law: “We do not disturb the holding in Edwards and other
decisions strictly interpreting section 16600 to invalidate noncompetition
8
To clarify, “partial sale” in this opinion refers to an owner’s sale
of a portion of his or her ownership interest in a company where the seller
remains an owner following the sale. As used here, “partial sale” does not
include the sale of an entire subdivision of a company, which might also be
construed as a partial sale of a company. (See, e.g., Martinez v. Martinez
(1953) 41 Cal.2d 704, 705-707 [noncompetition agreement following sale of
San Diego branch of a business was valid under section 16601].)
21
agreements following the termination of employment or sale of interest in a
business.” (Id. at p. 1159)
However, all the relevant cases cited by Ixchel involved the sale
of an entire business interest. (Ixchel, supra, 9 Cal.5th at pp. 1152–153, 1156
[discussing cases involving sale of a business interest]; Chamberlain v.
Augustine (1916) 172 Cal. 285, 286-287 [defendant sold his interest in a
foundry company] (Chamberlain); Merchants’ Ad-Sign Co. v. Sterling (1899)
124 Cal. 429, 430-431 [defendant sold all his shares in a bill posting business
(Merchants’ Ad-Sign)]; Gregory v. Spieker (1895) 110 Cal. 150, 150-152
9
[defendant sold entire food business] (Spieker).) None of these cases
considered whether a partial sale would trigger the per se standard, nor are
we aware of any such cases that Ixchel did not discuss.
Moreover, none of the above cases contain any analysis or express
any public policy that would apply to the partial sale of a business interest.
Rather, as noted by Ixchel, these cases contain sparse analysis. (See Ixchel, 9
Cal.5th at pp. 1152–1153.) For example, in Merchants’ Ad-Sign, the Court
simply concluded that “[t]he language of the Code is unmistakable: ‘Every
contract by which one [i.e., any person] is restrained from exercising a lawful
. . . business of any kind . . . is to that extent void.’ The allegation is, that
defendant agreed not to engage in the business of bill posting, which is a
lawful business. This was an agreement in restraint of trade, and therefore
9
Chamberlain states the seller sold 60 shares of stock, but it does
not state whether this was the seller’s entire interest in the company or only
a partial interest. (Chamberlain, supra, 172 Cal. at p. 286.) But the context of
the case indicates it was the sale of an entire interest. The opinion explains
the seller “desired to withdraw” from the company. (Id. at p. 286.) Further
the sales agreement allowed the seller to work as a “molder or laborer” at
other specified companies without violating the noncompetition agreement,
indicating he had no further involvement with the company. (Id. at p. 287.)
22
void.” (Merchants’ Ad-Sign, supra, 124 Cal. at p. 434.) Likewise, the Court in
Chamberlain observed that “[t]he [noncompetition] covenant in question
clearly operates to restrain the defendant from ‘exercising a lawful
profession, trade, or business,’ and as it does not fall within the exceptions
given in section 1673, it is, therefore, void.” (Chamberlain, supra, 172 Cal. at
10
p. 288.)
“‘It is axiomatic that language in a judicial opinion is to be
understood in accordance with the facts and issues before the court.’” (Ixchel,
supra, 9 Cal.5th at p. 1158; Nolan v. City of Anaheim (2004) 33 Cal.4th 335,
343 [“A decision . . . does not stand for a proposition not considered by the
court.”].) With this in mind, Ixchel and the above cases only hold the per se
standard applies to restraints arising from the sale of an entire business
interest. None of these cases address whether noncompetition agreements
arising from the partial sale of a business interest are invalid per se. Thus,
10
In Spieker, the business sale included goodwill, so the
noncompetition restriction was found partially valid under former Civil Code
section 1674 (the predecessor to section 16601). (Spieker, supra, 110 Cal. at
pp. 153–154.) The Court’s analysis focused on defendant’s breach of the valid
portion of the noncompetition agreement and the measure of damages. (Id. at
pp. 152–154.)
23
we must determine whether the per se or reasonableness standard applies to
11
partial sales.
We start by looking at the purpose behind section 16600:
“[S]ection 16600 evinces a settled legislative policy in favor of open
competition and employee mobility. [Citation.] The law protects Californians
and ensures ‘that every citizen shall retain the right to pursue any lawful
employment and enterprise of their choice.’ [Citation.] It protects ‘the
important legal right of persons to engage in businesses and occupations of
their choosing.’” (Edwards, supra, 44 Cal.4th at p. 946; Quidel Corporation v.
Superior Court of San Diego County, supra, 57 Cal.App.5th at p. 166
[“‘California courts have consistently declared [section 16600] an expression
of public policy to ensure that every citizen shall retain the right to pursue
any lawful employment and enterprise of their choice’”].)
As we read Ixchel, there are certain noncompetition agreements
that are so antithetical to section 16600’s purpose that they are invalid per
se. For example, restraints following an employee’s termination or the sale of
an entire business interest (absent an applicable exception) unquestionably
interfere with a person’s right to engage in an occupation or business of their
11
At oral argument on appeal, the Samuelians appeared to
suggest that Blue Mountain Enterprises, LLC. v. Owen (2022) 74 Cal.App.5th
537, addresses the proper standard as to partial sales. Since they raised this
case for the first time at oral argument, we did not allow them to discuss it.
We also find it inapposite. Blue Mountain involved the formation of a joint
venture where the seller transferred all of his ownership interest in his
company to a new entity. The other party to the joint venture was then given
a 50 percent interest in the new entity. (Id. at pp. 542–543.) The parties
disputed whether the seller had sold his entire interest in the company or
only half of it for purposes of section 16601. (Id. at pp. 550–552.) The court
found the seller had sold his entire interest, as such, section 16601 applied.
(Id. at pp. 553–554.) These issues are not pertinent to this case.
24
choosing. Thus, they are struck down without further analysis. (See Ixchel,
supra, 9 Cal.5th at pp. 1152–1153, 1158.) Yet, there are also some
noncompetition agreements whose effect on competition is unclear. Such
agreements must be scrutinized more closely to determine their
reasonableness. (See id. at pp. 1153–1156, 1160–1161.)
A noncompetition agreement arising from the partial sale of a
business is not so obviously anticompetitive that it necessarily conflicts with
section 16600’s purpose. For example, while noncompetition restraints
arising from the termination of employment are invalid per se, section 16600
“does not affect limitations on an employee’s conduct or duties while
employed. ‘While California law does permit an employee to seek other
employment and even to make some “preparations to compete” before
resigning [citation], California law does not authorize an employee to transfer
his loyalty to a competitor. During the term of employment, an employer is
entitled to its employees’ “undivided loyalty.”’” (Angelica Textile Services, Inc.
v. Park (2013) 220 Cal.App.4th 495, 509, second italics added.)
“The public policy behind Section 16600 is to ensure ‘that every
citizen shall retain the right to pursue any lawful employment and enterprise
of their choice’ [citation] and to encourage ‘open competition and employee
mobility’ [citation]; it is not to immunize employees who undermine their
employer by competing with it while still employed. ‘We state the obvious in
observing that no “firmly established principle of public policy” [citation]
authorizes an employee to assist his employer’s competitors.’ [Citations.] It
should be even more obvious that no firmly established principle of public
policy authorizes an employee to become his employer’s competitor while still
employed. Section 16600 is not an invitation to employees to bite the hand
25
that feeds them.” (Techno Lite, Inc. v. Emcod, LLC (2020) 44 Cal.App.5th 462,
473–474.)
An owner that sells their entire interest in a company is in a
similar position to a terminated employee: his or her connection to the
business has been severed. But similar to current employees, owners that
only sell a partial ownership interest remain owners of the company and may
still have a significant connection to it. Following a partial sale, the selling
owner could still be involved in operational decisions and/or receive
confidential financial information about the company. Given these potential
connections following a partial sale, a restriction barring the selling owner
from competing with the company is not so inherently anticompetitive as to
warrant application of the per se standard. Rather, such restrictions may
have procompetitive benefits. For example, they could ensure that owners are
invested in improving the company’s products or services, motivated to
optimize the company’s resources to expand into related lines of business,
and/or are not using private information to create or assist competing
businesses, among other things.
Because of their potential procompetitive benefits,
anticompetition restrictions following a partial sale require some scrutiny to
determine whether they are reasonable in light of the seller’s ongoing
connection with the company. Such restrictions should be evaluated under
the reasonableness standard to determine whether they are more harmful or
helpful to competition by “considering ‘“the facts peculiar to the business in
which the restraint is applied, the nature of the restraint and its effects, and
the history of the restraint and the reasons for its adoption.”’” (Ixchel, supra,
9 Cal.5th at p. 1150.)
26
Further, following a partial sale, selling owners may owe their
company a duty of loyalty that prohibits them from competing with it.
Adopting a per se standard to noncompetition restraints following partial
sales would unnecessarily interfere with these fiduciary duties and erode a
company’s ability to ensure its owners make decisions that benefit the
company.
As we explain in the next section, while the California Revised
Uniform Limited Liability Company Act (the “RULLCA”) does not impose
fiduciary duties on members in a manager-managed company, as is the case
12
here, it allows an operating agreement to impose such duties on members.
Moreover, members in a member-managed company owe
statutory fiduciary duties of loyalty and care to the company and other
members under the RULLCA. (Corp. Code, § 17704.09, subd. (a).) The duty of
loyalty includes “[t]o refrain from competing with the limited liability
13
company in the conduct . . . of the limited liability company.” (Corp. Code,
§ 17704.09, subd. (b)(3).) While the duty of loyalty can be narrowed, it cannot
be eliminated. (Corp. Code, § 17701.10, subd. (c)(4).) Thus, following a partial
sale in a member-managed company, the seller would remain a member of
the company and be bound by the duty of loyalty. (Corp. Code, § 17704.09,
12
In manager-managed limited liability companies, the RULLCA
imposes statutory fiduciary duties on managers but not members. (Corp.
Code, § 17704.09, subd. (f).)
13
The parties discuss whether we should apply the RULLCA or
its predecessor, the Beverly-Killea Limited Liability Act (Beverly-Killea), to
the operating agreement. (See CB Richard Ellis, Inc. v. Terra Nostra
Consultants (2014) 230 Cal.App.4th 405, 411, fn. 4 [the RULLCA replaced
Beverly-Killea].) We do not discuss Beverly-Killea because our concern is
with the fiduciary duties generally imposed under existing law, not the
specific fiduciary duties applicable to the Samuelians.
27
subds. (a) & (b).) Section 16600 would not invalidate the selling member’s
statutory duty of loyalty in a member-managed company. (See Angelica
Textile Services, Inc. v. Park, supra, 220 Cal.App.4th at p. 509; Techno Lite,
Inc. v. Emcod, LLC, supra, 44 Cal.App.5th at pp. 473–474.)
We recognize that section 16600’s application is limited to “every
contract” that restrains competition. (§ 16600, subd. (a).) It does not appear to
apply to the above statutory fiduciary duties imposed by the RULLCA on
members unless those duties are set forth in the operating agreement or
another contract. Accordingly, adoption of the per se standard to partial sales
could create absurd results. Consider a scenario in which after a partial sale,
the selling member signed a new operating agreement or other contract that
simply reiterated its fiduciary duties under the RULLCA. Under the per se
standard, this provision would seemingly be void without any analysis. (See
Ixchel, supra, 9 Cal.5th at p. 1151 [per se standard invalidates
noncompetition agreement “without inquiring into their reasonableness”].) It
makes no sense that a statutorily imposed duty of loyalty would be valid if
unstated in a contract but would be invalid if repeated in one. In contrast,
under the reasonableness standard, a court could conclude the restraint was
enforceable because it was mandated by the RULLCA.
We also note other potential conflicts between the RULLCA and
section 16600 that could arise if we applied the per se standard to partial
sales. The RULLCA allows an operating agreement to make some alterations
to the duty of loyalty owed by members in a member-managed company. The
duty of loyalty cannot be entirely eliminated (Corp. Code, § 17701.10, subd.
(c)(4)), but an operating agreement can narrow it in two ways: (1)
“[i]dentify[ing] specific types or categories of activities that do not violate the
duty of loyalty, if not manifestly unreasonable”; and/or (2) “[s]pecify[ing] the
28
number or percentage of members that may authorize or ratify, after full
disclosure to all members of all material facts, a specific act or transaction
that otherwise would violate the duty of loyalty.” (Corp. Code, § 17701.10,
subd. (c)(14)(A) & (B).) Conversely, in a member-managed company, the
operating agreement can expand the members’ statutory duty of loyalty “in a
written operating agreement with the informed consent of the members.”
(Corp. Code, § 17701.10, subd. (e); Soza, et al., Cal. Practice Guide: Pass—
Through Entities (The Rutter Group 2023) ¶ 6:501, p. 61.)
Following a partial sale in a member-managed company, if a new
operating agreement broadened the members’ statutory duty of loyalty by
adding noncompetition restraints, such restraints would be invalid per se
even though they are permitted by the RULLCA. (Corp. Code, § 1170.10,
subd. (e).) Or, if a new operating agreement sought to narrow the members’
duty of loyalty in accordance with the RULLCA (Corp. Code, § 17701.10,
subd. (c)(14)(A) & (B)), these modifications would also be invalid per se. (See
Chamberlain, supra, 172 Cal. at pp. 287–289 [partial restraints are invalid
per se].)
“‘A court must, where reasonably possible, harmonize statutes,
reconcile seeming inconsistencies in them, and construe them to give force
and effect to all of their provisions.’” (See Pacific Palisades Bowl Mobile
Estates, LLC v. City of Los Angeles (2012) 55 Cal.4th 783, 805.) To avoid
potential conflicts between section 16600 and the RULLCA, we find the
reasonableness standard applies to section 16600 when evaluating
noncompetition agreements following partial sales. When applying this
standard, courts can determine the reasonableness of any contractual
fiduciary duties placed on a member in a manager-managed or member-
managed company.
29
Next, as to the arbitrator’s second ground, we find this case to be
more similar to Ixchel than Edwards for the reasons set forth above. Edwards
involved a noncompetition agreement arising from the termination of
employment. Like a terminated employee, an owner that sells their entire
interest in a company generally has no further connection or involvement
with the company. However, where a partial sale occurs, the owner remains
an owner of the company and may be involved with its operation. That
ongoing connection separates a seller of a partial interest from a terminated
employee. The scenario we face here is markedly different than Edwards.
This case shares more in common with the noncompetition
restraints between businesses in Ixchel because there is an ongoing
relationship between the Samuelians and the Company. As outlined above,
the Samuelians still have some control over the Company. Due to this
continued relationship, the noncompetition provision may have
procompetitive effects unlike the case of a terminated employee. Given the
control the Samuelians still possess over the Company, the restraints here
require further scrutiny to determine whether they are reasonable.
As to prejudice, the trial court found any error in applying the
per se standard was not prejudicial due to the arbitrator’s finding in the
Phase One that the noncompetition provision was unreasonable under
section 16601. But, during the reconsideration motion hearing, the arbitrator
clarified this prior statement was not a binding ruling. The arbitrator
acknowledged he had made “rulings that prohibited [the Company] from
putting on evidence that would have gone to the reasonableness issues.”
Thus, he clarified his prior statement that the noncompetition provision was
unreasonable was “dictum.” The arbitrator also stated that if Ixchel required
30
the reasonableness standard to be applied here, he would need to hold
another hearing as to the provision’s reasonableness.
Based on the above statements from the arbitrator, we find the
error was prejudicial. There is more than an abstract possibility that the
noncompetition provision could have been found to be enforceable had the
arbitrator applied the reasonableness standard. (See Cassim v. Allstate Ins.
Co., supra, 33 Cal.4th at p. 800.)
The arbitrator’s ruling invalidating the corporate opportunities
provision was based on the same legal analysis as the noncompetition
provision. As such, this portion of the ruling is also erroneous and prejudicial
for the reasons above. To the extent the Company argues the corporate
opportunities provision should be treated differently than the noncompete
provision, we disagree. The arbitrator found the two provisions were
intertwined and could not be severed from each other. This is a factual
finding that we lack authority to review.
D. Members’ Fiduciary Duties in a Manager-Managed Company
Both the arbitrator and the trial court found an operating
agreement could not impose noncompetition restrictions on members in a
manager-managed company. We disagree.
First, similar to the discussion above, nothing in section 16600’s
purpose suggests that any such noncompetition restrictions are invalid per
se. The public policy behind section 16600 does not authorize employees to
compete with their current employer. (Techno Lite, Inc. v. Emcod, LLC,
supra, 44 Cal.App.5th at pp. 473–474.) Similarly, it should not make a
company powerless to ensure its current owners do not open or assist
competing businesses, so long as such restrictions are reasonable. As
mentioned above, a member in a manager-managed limited liability may
31
have some control over the company’s operations, as is the case here. In such
scenarios, noncompetition restrictions could be enforceable if they have
procompetitive effects. (Cf. Ixchel, supra, 9 Cal.5th at pp. 1160–1162.) It could
be reasonable for a company to require its owners to refrain from certain
competitive activities and ensure their focus is on growing and improving the
company.
Here, for instance, the Samuelians’ consent was required to
(1) change the operating agreement, (2) make any split, combination, or
reclassification of membership interests, (3) form certain agreement between
the Company and an owner, owner’s family member, or entity affiliated with
an owner, (4) engage the Company in a new line of business, or (5) make
changes to Mastrocola’s terms of employment. The Company was also
required to send the Samuelians private financial information. Given this
level of involvement, it could have been reasonable to impose certain
noncompetition restrictions on the Samuelians to eliminate conflicts of
interest that could compromise their decisionmaking and ensure they were
committed to the Company’s success.
Second, nothing in the RULLCA bars an operating agreement
from imposing reasonable noncompete restrictions on members in a manager-
managed company. While the RULLCA does not affirmatively impose any
such fiduciary duties, it is only intended to provide default rules where a
company’s operating agreement is silent. (Corp. Code, § 17701.10, subd. (b).)
As treatises have explained, “The [RULLCA] is a ‘default’ statute—meaning
that in the absence of agreement otherwise by the members of the LLC in the
operating agreement . . . , the statute sets forth the rights, obligations and
the duties of the members, managers (if any) and officers (if any) of the LLC
to third parties and amongst themselves.” (Olson, Cal. Bus. Law Deskbook
32
(2023) § 3:1; Gutterman, 3A Cal. Transactions Forms—Bus. Entities (2023)
§ 16:65 [“While the specific statutory language of the RULLCA provides
many of the operational provisions for an LLC (referred to as the ‘default’
provisions), the members have broad latitude to change them in the
operating agreement”].)
The RULLCA lists certain matters that “an operating agreement
shall not do . . . .” (Corp. Code, §§ 17701.10, subds. (c) & (d).) For example, an
operating agreement cannot eliminate the statutory fiduciary duties imposed
on a member in a member-managed company or a manager in a manager-
managed company. (Corp. Code, § 17701.10, subd. (c)(4), (14), (15).) But
nothing in these subdivisions bars an operating agreement from imposing
fiduciary duties on members in a manager-managed company. (See Corp.
Code, § 17701.10, subds. (c) & (d).)
In reaching a different conclusion, the trial court relied on a
portion of the RULLCA stating that “[t]he fiduciary duties of a manager to a
manager-managed limited liability company . . . and of a member to a
member-managed limited liability company . . . shall only be modified in a
written operating agreement with the informed consent of the members.”
(Corp. Code, § 17701.10, subd. (e).) The court believed this subdivision,
“expressly limit[s] creation of fiduciary duties.” And it concluded that “[h]ere,
there is no dispute that the Samuelians were minority members of a
manager-managed LLC and thus had no fiduciary duties that could be
‘modified.’”
The trial court read too much into Corporations Code
section 17701.10, subdivision (e). It has a much narrower application. This
subdivision only provides that modifications of fiduciary duties imposed on
managers or members must be made in writing with informed consent. But
33
nothing in this subdivision prevents an operating agreement from creating
fiduciary duties for members in a manager-managed company. Indeed, other
provisions of the RULLCA allow for such duties to be imposed.
Corporations Code section 17704.09 sets forth the fiduciary
duties of members in a member-managed company and managers in a
managed-managed limited liability company. It creates a default rule in
which members in a manager-managed company do not owe fiduciary duties
to the company or other members. (Corp. Code, § 17704.09, subd. (f)(1)-(3).)
But this default rule can be displaced. This section specifies that in manager-
managed companies, “[e]xcept as otherwise provided, a member does not have
any fiduciary duty to the limited liability company or to any other member
solely by reason of being a member.” (Corp. Code, § 17704.09, subd. (f)(3),
italics added.)
The phrase “except as otherwise provided” suggests members in a
manager-managed company can have fiduciary duties where “provided,” such
as if imposed by an operating agreement. The statute’s text is broad enough
to support this interpretation. Significantly, “[e]xcept as otherwise provided,”
is not qualified in Corporations Code section 17704.09, subdivision (f)(3). But
the RULLCA expressly qualifies other exceptions. (See, e.g., Corp. Code,
§ 17701.10, subd. (a) [“Except as otherwise provided in this section”]; Corp.
Code, § 17701.10, subd. (c)(11) [“Except as otherwise provided in subdivision
(b) of Section 17701.12”]; Corp. Code, § 17701.10, subd. (c)(12) [“Except as
provided therein, vary any provision under Article 10”]; Corp Code,
§ 17702.03, subd. (a)(1) [“Except as otherwise expressly provided in this title
and in this subdivision”]; Corp Code, § 17704.07, subd. (c)(1) [“Except as
otherwise expressly provided in this title”].)
34
If the Legislature intended for courts to narrowly interpret or
otherwise limit the phrase “[e]xcept as otherwise provided,” in Corporations
Code section 17704.09, subd. (f)(3), it knew how to do so. Since it did not, we
can infer this statement should be broadly interpreted and can be read to
encompass operating agreements. Here, for example, it could be read to state
that “[e]xcept as otherwise provided” in the operating agreement, “a member
does not have any fiduciary duty to the limited liability company or to any
other member solely by reason of being a member.” (See Corp. Code, §
17704.09, subd. (f)(3).)
In sum, we conclude an operating agreement can impose
fiduciary duties on members in a manager-managed company. If a
noncompetition restriction is included in these fiduciary duties, it should be
evaluated under the reasonableness standard.
E. The Samuelians’ Arguments
We do are not persuaded by any of the Samuelians’ arguments
opposing application of the reasonableness standard.
The Samuelians claim application of the reasonableness standard
instead of the per se standard “would render the statutory scheme
incoherent. Noncompete agreements arising from ‘the sale of interest in a
business’ are generally per se invalid (Ixchel, [supra,] 9 Cal.5th at pp. 1151–
1152, 1156, 1159), but agreements arising from the sale ‘of all of [a party’s]
ownership interest in the business’ are generally valid (Bus. & Prof. Code, §
16601, italics added). Ixchel’s holding makes sense only if sales of some of a
party’s interests trigger the rule of per se invalidity; otherwise, section
16601’s statutory exception would make that holding a null set.”
We disagree. As discussed above, section 16601 generally allows
limited noncompetition agreements to be enforced following the sale of an
35
entire business interest. Prior to 1945, however, section 16601 (and its
predecessor, former Civil Code section 1674) only allowed enforceable
noncompetition agreements if the owner sold the goodwill of a business.
(Bosley Medical Group v. Abramson (1984) 161 Cal.App.3d 284, 288–289.)
The exception in section 16601 (and its predecessor) did not apply to the sale
of an entire business interest unless the sale expressly included goodwill.
(Ibid.; see, e.g., Chamberlain, supra, 172 Cal. at pp. 287–288.) This changed
in 1945, when section 16601 was amended to allow valid noncompetition
agreements to be formed following the sale of an entire business interest that
do not expressly include the business’s goodwill. (Bosley, supra, at p. 289,
italics omitted.)
Following this amendment, though, section 16601 still does not
apply to all sales of an entire business interest. For section 16601 to apply,
some goodwill must still be included in the sale. (In re Marriage of Greaux &
Mermin (2014) 223 Cal.App.4th 1242, 1251.) For example, “there must be a
clear indication that in the sales transaction, the parties valued or considered
goodwill as a component of the sales price, and thus the share purchasers
were entitled to protect themselves from ‘competition from the seller which
competition would have the effect of reducing the value of the property right
that was acquired.’” (Hill Medical Corp. v. Wycoff (2001) 86 Cal.App.4th 895,
903.) Likewise, the noncompetition restraint is only valid “in situations in
which the transfer of ‘all’ of the owner’s shares involves a substantial interest
in the corporation so that the owner, in transferring ‘all’ of his shares, can be
said to transfer the goodwill of the corporation.” (Bosley Medical Group v.
Abramson, supra, 161 Cal.App.3d at p. 290.)
Our holding would not nullify Ixchel’s statement that
noncompetition restraints following the sale of a business interest are invalid
36
per se. Noncompetition restraints following the sale of an entire business
interest are still invalid per se if they do not include any goodwill, e.g., where
the seller did not own a “substantial interest” in the company or where
goodwill was not considered in the sales price. For example, a restraint
arising from an owner’s sale of its entire one percent interest in a company
would likely not meet the requirements of section 16601 and would be invalid
per se. (See, e.g., Hill Medical Corp. v. Wycoff, supra, 86 Cal.App.4th at pp.
907–908 [sale of seven percent interest “did not involve a substantial interest
such that it could be said that the transfer of goodwill was considered” in the
sale].)
The Samuelians also highlight the trial court’s finding that “the
record . . . reflects that [Section 6.4] arose in connection with the termination
of employment. But the arbitrator never made this factual finding. Indeed,
his order denying the reconsideration motion concluded, this “is not an
employment contract case . . . involving an employee.” None of the parties
claim the court had authority to review the arbitrator’s factual findings. And
we will not make that argument for them. (See City of Riverside v. Horspool,
supra, 223 Cal.App.4th at p. 679, fn. 8.)
F. Attorney Fees and Costs
Due to our findings above, we also vacate the arbitrator’s award
of attorney fees and costs to the Samuelians.
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DISPOSITION
The judgment is reversed. The superior court is directed to enter
an order denying the Samuelians’ petition to confirm the award and granting
the Company’s motion to vacate the entire award, including the portion
awarding attorney fees and costs. Defendants are entitled to their costs on
appeal.
MOORE, ACTING P. J.
WE CONCUR:
GOETHALS, J.
SANCHEZ, J.
38