A Tale of Two Statutes: Cipro, Edwards, and the Rule of Reason

• Jurisdiction: California,United States
• Author: By Steven M. Perry and Sean F. Howell
• Publication year: 2015
• Citation: Vol. 24 No. 2

A TALE OF TWO STATUTES: CIPRO, EDWARDS, AND THE RULE OF REASON

By Steven M. Perry and Sean F. Howell¹

I. INTRODUCTION

This article tells the tale of two statutes that were enacted around the same time, that address many of the same issues, and that were interpreted for over one hundred years in the same way by the California courts. Recently, however, attempts have been made to tear apart these statutory neighbors. We speak, of course, of California's two antitrust statutes: the Cartwright Act, enacted in 1907, and Business & Professions Code section 16600, enacted in 1872.

The operative language of each of these statutes is set out below:

• Section 16600
• "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."
• Cartwright Act—Section 16726
• "Except as provided in this chapter, every trust is unlawful, against public policy and void."²

Although section 16600 and the Cartwright Act each employs absolutist language in describing its reach, the California Supreme Court has long interpreted both statutes as permitting "reasonable" restraints.³ As a consequence, the Cartwright Act and section 16600 have existed in near-perfect harmony since the former was enacted. Under each statute, certain kinds of restraints on trade were presumed to be anticompetitive and were deemed invalid as a matter of law, while a more thorough analysis of market effects was employed when addressing other types of agreements.

Recently, however, litigants and amici have suggested that a 2008 Supreme Court decision, Edwards v. Arthur Andersen LLP,⁴ created an enormous rift in California's antitrust landscape. Although Edwards concerned a covenant not to compete in an employment agreement, some have contended that the Edwards court established a broad rule that all agreements that in any way restrain trade, whether in the employment context or in the broader universe of commercial activity, are per se void. For example, the California Attorney General filed an amicus brief in the Cipro case⁵ that asserted that Edwards "sets out a general rule in California making all contracts restraining trade illegal per se under California law (save for statutory exceptions), and not subject to a rule of reason analysis."⁶ The Attorney General's brief relied on a statement in Edwards that "[s]ection 16600 is unambiguous, and if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect."⁷

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The potential consequences of such a black-and-white legal regime—where all agreements that restrain trade to any extent are void, no matter how procompetitive they might be—are staggering. As Justice Brandeis observed in 1918 in the course of explaining why the Sherman Act forbade only unreasonable restraints, "[e]very agreement concerning trade, every regulation of trade, restrains. To bind, to restrain, is of their very essence."⁸ If the California Supreme Court in Edwards did, in fact, intend 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 section 16600.

This article posits that Edwards' precedential reach is not nearly so expansive. An examination of the procedural history of the Edwards case, both at the Court of Appeal and at the Supreme Court, reveals that those courts had limited the scope of their review and their holdings to non-competition provisions in employment agreements, where California's particularly strong public policy favoring employee mobility would play a significant role in the analysis. It is, of course, fundamental that a decision, even a Supreme Court decision, "is not authority for what is said in the opinion but only for the points actually involved and actually decided."⁹ The Edwards court thus should not be presumed to have held invalid large numbers of agreements outside the employment context given that it had explicitly limited its review (and the parties' briefing) to the employment context.

In addition, as we explain in this article, any holding by the Edwards court that agreements challenged under section 16600 could never be subjected to a rule of reason analysis would be directly contrary to two California Supreme Court decisions that the Edwards court did not mention. It is very unlikely that the Supreme Court intended to overrule at least two of its own longstanding precedents without even mentioning those decisions or explaining why they were no longer good law.¹⁰

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The Edwards opinion is thus best understood as another in a long line of Court of Appeal and Supreme Court cases that have treated employee non-compete agreements as presumptively invalid under section 16600. Under that approach, as described in this article, the mode of analysis under section 16600 would mirror the framework applied in Cartwright Act cases, as most recently described in Cipro: (1) Certain categories of agreements and practices that "can be said to always lack redeeming value" may be held per se invalid without extensive analysis; and (2) Agreements falling outside the per se category will be subject to a "nuanced" analysis of "the circumstances, detail, and logic" of the challenged restraint in order to "determine whether an agreement harms competition more than it helps."¹¹

This proposed approach to Edwards, and to section 16600 analysis more generally, has two additional virtues: (1) By harmonizing the antitrust analysis applicable to California's two antitrust statutes, the proposed approach recognizes and applies the basic principle of statutory interpretation that courts "should adopt[ ] the construction that best harmonizes the statute internally and with related statutes;"¹² and (2) The proposed approach acknowledges that the California Legislature has "effectively codifie[d]" the traditional rule of reason in Cal. Bus. & Prof. Code § 16725, which provides that "[i]t is not unlawful to enter into agreements or form associations or combinations, the purpose and effect of which is to promote, encourage or increase competition in any trade or industry, or which are in furtherance of trade."¹³

In the pages that follow, we first describe the analytical framework set out by the California Supreme Court in Cipro. We then trace the history of section 16600 jurisprudence and explain how the California courts developed a two-pronged analytical framework for section 16600 claims that essentially mirrored the framework used by courts to address Sherman Act and Cartwright Act claims, set out most recently in Cipro. Finally, we explain why Edwards fits comfortably into the courts' two-pronged approach to section 16600 claims, and why it would be inappropriate to assume that the Edwards court intended to create a schism between section 16600 and the Cartwright Act by holding that all restraints on trade, no matter how limited or procompetitive, are void under section 16600.

II. CIPRO AND THE RULE OF REASON UNDER THE CARTWRIGHT ACT

At issue in Cipro was the legality of "reverse payment" settlements of patent lawsuits involving pharmaceutical companies. The Cipro court described such settlements as involving a payment by a plaintiff (a brand-name drug manufacturer that holds fundamental patents on a drug) to a defendant (a generic drug manufacturer that has announced plans to enter the market for that drug).¹⁴ In return for the payment by the patentholder, the generic drug manufacturer drops its challenges to the validity of the plaintiffs' patents and often agrees to stay out of the market for a period of time.¹⁵ The case before the court involved consumer class actions under the Cartwright Act that had been filed against a brand-name drug manufacturer and a generic manufacturer who had reached such a settlement agreement in 1997.¹⁶

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The relevant portions of the Cipro decision for our purposes are those where the court addressed the analytical framework that would be used to decide the plaintiffs' Cartwright Act claims. The court began by explaining that although "the Cartwright Act is written in absolute terms, in practice not every agreement within the four corners of its prohibitions has been deemed illegal. "¹⁷ Put differently, "deciding antitrust illegality is not as simple as identifying whether a challenged agreement involves a restraint of trade¹⁸," despite the "superficially absolute language" used in the Cartwright Act.¹⁹ Instead, courts must "determine whether an agreement harms competition more than it helps," for "only unreasonable restraints of trade are prohibited."²⁰

After surveying the historical development of the rule of reason under both federal and California antitrust law, the Cipro court confirmed that the rule of reason will continue to be applied to Cartwright Act claims unless the challenged restraint falls into one of the "categories of agreements or practices that can be said to always lack redeeming value and thus qualify as per se illegal," such as cartel agreements.²¹ The Cipro court placed in the presumptively illegal category all agreements between competitors "to establish or maintain a monopoly."²²

The Cipro court also explained that there is no rigid formula that courts must use when applying the rule of reason. Instead, because "nothing in the text of the Cartwright Act dictates the precise details of the per se and rule of reason approaches," the courts should consider "the circumstances, details, and logic" of the challenged restraint and employ a "nuanced" approach in order to achieve the ultimate goal of determining whether an agreement is "unreasonable."²³ The Cipro court also concluded that courts faced with a Cartwright Act challenge "must...