California
Partner Departure Law

July 08, 2013

California Supreme Court and Non-Compete Provisions in Partnership Agreements: Howard v. Babcock Holds that Partners Imposing a Reasonable Toll on Departing Partners who Compete with the Firm is Enforceable

Prior to considering departing from an existing partnership, a partner needs to give careful consideration and analysis to any non-compete agreement or restrictions on his/her right to practice law imposed by the existing partnership agreement. Understanding these types of provisions and their potential enforceability can properly shape a departing partners strategy for departure and help to minimize risk and potential liability when the departing partner leaves the existing firm.

The California Supreme Court ruling in Howard v. Babcock is still the seminal case in analyzing and defining the validity of non-compete agreements between departing partners in partnership agreements. (Howard v. Babcock, (1993) 6 Cal.4th 409.) Typically contractual limitations restricting or penalizing competition among former employees and employers are void and unenforceable under Business & Professions Code section 16600.  Section 16600 provides that “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”  However, such restrictions contained in partnership agreements in anticipation of dissolution or partner departure are excluded from this rule by Section 16602.

Specifically, Section 16602 provides: “Any partner may, upon or in anticipation of a dissolution of the partnership, agree that he will not carry on a similar business within a specified county or counties, city or cities, or a part thereof, where the partnership business has been transacted, so long as any other member of the partnership, or any person deriving title to the business or its goodwill from any such other member of the partnership, carries on a like business therein.”

In Howard, the California Supreme Court held that Section 16602 applies to attorneys in a law partnership, even though it appears to conflict with California Rules of Professional Conduct, Rule 1-500.  The Supreme Court stated, “[a]n agreement that assesses a reasonable cost against a partner who chooses to compete with his or her former partners does not restrict the practice of law.  Rather, it attaches an economic consequence to a departing partner’s unrestricted choice to pursue a particular kind of practice.”  (Howard, 6 Cal.4th at 419.)  The Howard agreement did not contain a non-compete clause, per se, but imposed a penalty or compensation to the firm in the event of competition.  Specifically, the Howard provision read:

“ARTICLE X. Should more than one partner, associate or individual withdraw from the firm prior to age sixty-five (65) and thereafter within a period of one year practice law … together or in combination with others, including former partners or associates of this firm, in a practice engaged in the handling of liability insurance defense work as aforesaid within the Los Angeles or Orange County Court system, said partner or partners shall be subject, at the sole discretion of the remaining non-withdrawing partners to forfeiture of all their rights to withdrawal benefits other than capital as provided for in Article V herein.”  (Id. at p. 413.)

Article X of the partnership agreement at issue in Howard also provided that if only one partner withdraws, he or she is subject to forfeiture of 75 percent of the withdrawal benefits for competition in Orange County or Los Angeles County, and 25 percent of the withdrawal benefits if he or she competes in specified other counties.  (Id. at p. 413.)

In holding that the Howard restriction on competition was facially valid, the Court concluded that it found no legal justification for treating partners in law firms differently in this respect from partners in other businesses and professions.  (Id. at p. 422.)  In rendering its decision, the Court was not persuaded by arguments relating to the freedom of an attorney to practice law or the freedom of clients to select their own attorneys.  (Id. at 423.)  The Court reasoned that attorneys do not have the right to enter into partnerships with any particular firm and may be forced out at any time by the other partners despite a client’s request.  Furthermore, no attorneys have a duty to take a specific client and, likewise, (in the civil context), a client does not have the right to attorneys services.  (Id.)

However, not every agreement between partners in restraint of competition is permitted. The Supreme Court held that the common law “rule of reason” should apply to evaluate a non-competition agreement under Section 16602.  (Howard, 6 Cal.4th at 416.)  The amount fixed in an agreement for competition must represent “a reasonable endeavor to estimate a fair compensation for the loss that may be sustained, and must bear some reasonable relation to such loss.”  (Id. at 417.)