California NonCompete and Non-Voting StockIssues

Quick Summary

Owning non-voting stock does not create ownership of a corporation which can be used to enforce a noncompete.

The owner of a business selling their stock can be subject to a limited non-compete agreement. Non-voting stock, however, does not create an ownership interest. It is just an investment.

Law Review

As a general rule, noncompete agreements are not enforceable in California. (Business & Professions Code 16600.)

However, an exception applies when owners of a business sell. (Business & Professions Code 16601.)

What about a person who owns non-voting stock?

Initially, a corporation must always have voting stock. Non-voting stock, often called Class B stock, does not give the holder any ownership or control of the company. Rather, the stock is an investment. Really, it is just extra compensation for employment but instead of the company paying valuable cash the compensation is called stock. This is stock which typically cannot be sold on the market.

Section 16601 permits a limited non-compete against anyone:

"owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity, or any owner of a business entity"

The section further defines "owner of a business entity" to mean someone who is an owner of "capital stock."

The reference to "ownership interest in the business" means a "capital stockholder."

Capital stock is a catch-all which includes all company stock, whether voting or non-voting.

The courts, however, have interpreted the statute to mean a "real owner" of a business. Not a person who owns one share.

For example, if an employee of Google, Inc., owns one share, a non-compete will be not enforced against them if they sell their share.

Section 16601 includes another term which apparently has not been the subject of litigation: "business so sold."

The statute, in full, reads the owner of a business can agree to refrain from conducting a business like the "business so sold" so long as the buyer remains in business.

This signifies more than a simple stock sale, especially one involving non-voting stock. There must be an actual sale of of business for a business to be "sold."

Additionally, section 16601 refers to the "person deriving title to the ... ownership interest from the buyer."

When non-voting stock is returned to the corporation it makes little sense to clam an ongoing corporation has had a change in ownership interest. It hasn't. The business has not been sold to itself. That makes no sense.

This is particularly true when the stock is required to be re-sold to the company when an employee terminates their employment.

In this circumstance I have never heard of a court treating the employee as an owner. Rather, they have compensation in the form of restricted, non-voting stock which is required to be converted to cash upon their employment leaving. This is not a voluntary sale and not a sale of equity or the business.

The non-compete exception for owners would not be triggered in this instance.

Attorney Brian Kindsvater specializes in noncompete issues.

If you or your corporate attorney need assistance with noncompete issues, contact Mr. Kindsvater here:

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