August 6, 2020

Economic Tort of Tortious Interference With At-Will Contractual Relations Requires Allegation of Independent Wrongful Act

In Ixchel Pharma, LLC v. Biogen, Inc., S256927, 2020 WL 4432623 (Cal. Aug. 3, 2020) (“Ixchel Pharma”), the Supreme Court of California clarified two points: (1) that to state a claim for interference with an at-will contract by a third party, the plaintiff must allege that the defendant engaged in an independently wrongful act, and (2) whether contractual restraints on business-to-business contracts are invalid depends on whether the restraint is reasonable. 

Plaintiff Ixchel Pharma, LLC (“Ixchel”) sued Biogen, Inc. (“Biogen”), in federal court for tortiously interfering with Ixchel’s contractual and prospective economic relationship with Forward Pharma (“Forward”). Ixchel and Forward entered into a collaboration agreement (the “Ixchel-Forward Agreement”) to develop a drug containing the active ingredient dimethyl fumarate (“DMF”) that treats a specific neurological disease. The drug development had been going according to plan until Forward decided to withdraw from the agreement, which was allowed by its terms. Forward withdrew based on a settlement and license agreement between Forward and Biogen (the “Forward-Biogen Agreement”), which included a provision that required that Forward terminate any and all existing contracts with Ixchel related to the development of any drug with DMF as an active ingredient (the “Non-Compete Provision”). Ixchel sued Biogen arguing that the Non-Compete Provision tortiously interfered with the Ixchel-Forward Agreement. The district court granted Biogen’s motion to dismiss Ixchel’s claims, concluding that because the Ixchel-Forward Agreement was terminable at will, Ixchel had to plead that Biogen engaged in an independently wrongful act. Ixchel amended its complaint to allege that by including the Non-Compete Provision in the settlement agreement, Biogen had committed the wrongful act of violating Business & Professions Code section 16600’s prohibition against restraints of trade. Biogen moved to dismiss again and the district court again dismissed the complaint, this time on the grounds that the Forward-Biogen Agreement must be analyzed under the antitrust rule of reason and that section 16600 does not apply outside the employment context. Accordingly, the district court ruled that Ixchel’s alleged harms were entirely speculative and did not sufficiently allege harm to competition.

Ixchel appealed to the Ninth Circuit Court of Appeals, which certified two questions to the Supreme Court of California. The Supreme Court of California rephrased the questions as follows: (1) Is a plaintiff required to plead an independently wrongful act in order to state a claim for tortious interference with a contract that is terminable at will? and (2) What is the proper standard to determine whether section 16600 voids a contract by which a business is restrained from engaging in a lawful trade or business with another business?

On the first question, the Supreme Court of California held that Ixchel must allege that Biogen committed an independently wrongful act in order to state a claim for tortious interference with contract in light of the fact that the Ixchel-Forward Agreement is an at-will contract. The Court recognized that the two economic relations torts of interference with contractual relations and interference with a prospective economic advantage are related, but distinct. While both torts protect the public interest in stable economic relationships, one tort requires the existence of a legally binding contract, while the other does not, and where there is no legally binding contract, the plaintiff is required to plead an independently wrongful act other than the fact of interference itself. The Court determined that, like parties to a prospective economic relationship, parties to at-will contracts have no legal assurance of future economic relations. At-will contractual relations are not cemented in the way that a contract not terminable at will is, making the interest in protecting the contract from interference more closely aligned with that of the prospective economic relationship. Allowing interference with at-will contract claims without requiring independent wrongfulness risks chilling legitimate business competition and may expose routine and legitimate business competition to litigation.

On the second question the Supreme Court held that, when read in the context of the statutory framework as a whole, section 16600 is best read not to render void per se all contractual restraints in business-to-business agreements, but rather to subject each to a rule of reason. As an initial matter, the Court agreed with the parties that section 16600 applies to business contracts. After looking at the statute’s history and its own precedent, the Court concluded that two discernible categories of holdings emerged in the case law: (1) agreements not to compete after the termination of employment or the sale of interest in a business were per se invalid without regard to their reasonableness; and (2) agreements containing restraints in “business operations or commercial dealings” were generally invalid if they were unreasonable. The Court made a clear that the application of the rule of reason is only for business-to-business agreements, and that the per se rule from Edwards v. Arthur Andersen LLP, 44 Cal.4th 937 (2008), and other decisions strictly interpreting section 16600 to invalidate noncompetition agreements following the termination of employment or sale of interest in a business remain good law and are not impacted at all by its ruling. 

The Ixchel Pharma decision makes two important rulings. First, it clarifies that an allegation of independent wrongful conduct is necessary when the agreement is terminable at will by either party, but it leaves open the question of what an “at-will” business contract looks like. Second, it applies the rule of reason standard to non-compete provisions in business-to-business agreements. Each of these holdings leave businesses with more questions than answers. The Court did not address what constitutes an “at will” business contract, and the application of the rule of reason standard to business-to-business contracts appears to ignore both the text of section 16600 and over 100 years of case law rejecting such an approach. It remains to be seen how courts will apply the reasonableness standard to business-to-business agreements. The Court did stress that section 16600 as applied to restraints between businesses must be read in conjunction with the Cartwright Act where courts have determined reasonableness based on an analysis of whether the contractual restraint promotes competition more than it hinders competition. Both rulings are expected to lead to more litigation and confusion. In the meantime, businesses and the attorneys that represent them, should evaluate their business-to-business contracts that are terminable by either party to determine if those agreements appropriately protect their interests.