Choice Of Law Issues That Arise When Non-Compete Provisions Cross State Lines

Thursday April 9, 2015

With an increase in employee mobility and the prevalence of both employers and employees operating across state lines, courts are frequently faced with a choice of law analysis when analyzing the enforceability of non-competition agreements. 

 

A Recent Decision from the Eastern District of North Carolina

 

A recent decision from the Eastern District of North Carolina exemplifies the complexities that are involved with the enforcement of a non-compete provision across state lines.  (Domtar AI Inc. v. J.D. Irving, Ltd. (E.D.N.C., Aug. 20, 2014) 2014 WL 4162440.)  Domtar involved an employee who had signed an employment agreement which included a non-competition clause.  Several years later, the employee resigned and left to work for a competing company. 

In Domtar, the employment agreement had been prepared in Georgia by the employer, presented to the employee in Georgia, and executed in Georgia.  The agreement was silent as to the choice of law.  The court sitting in diversity applied the choice of law rules of North Carolina, which apply the law of the place where the contract was formed unless an express or implied contrary intent rebuts that presumption.  Accordingly, the Domtar court held that the breach of contract claim relating to the non-compete provision would be analyzed under the laws of Georgia.  Under Georgia law, the court considers the reasonableness of the duration and territorial scope when deciding on the enforceability of a non-compete clause.  This approach is in stark contrast to California, where non-compete clauses are deemed to be unenforceable except under certain limited circumstances.

 

Choice of Law Considerations Involved in Reforming Non-Compete Clauses

 

In Domtar the choice of law analysis was also critical as to whether the court could reform the clause to make it reasonable and enforceable.  The so-called “blue-pencil” approach is a judicial doctrine where a court will strike out unreasonable provisions of a contract and then enforce it as deemed reasonable by the court.  After finding that Georgia law applied, the Domtar court noted that “blue-penciling” was not permitted under Georgia law and “therefore, if any restriction is unenforceable, all restrictions are unenforceable.” 

Other states, through case law or statute, take the “blue-pencil” approach even further and allow for “equitable reformation” wherein the court is permitted to rewrite the non-compete restriction to make it reasonable, even when it is necessary to do more than striking certain words from the agreement.  Neither the “blue-pencil” or “equitable reformation” approaches are relevant in California where only a discrete subset of non-compete clauses are enforceable.

 

Enforcement of a Choice of Law or Choice of Forum Agreement in California

 

Although, contractual choice of law clauses are commonplace in employment agreements, the contract at issue in Domtar did not include a choice of law provision.  In California, the inclusion of a choice of law provision does not necessarily mean that it will be enforced.  California courts will generally apply the designated choice of law unless the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties choice, or application of the law of the chosen state would be contrary to a fundamental policy of the state. 

 

The Race to the Court House

 

The enforceability of non-compete provisions may be dictated by the party that elects the forum by filing first.  For example, inGoogle Incv. Microsoft Corp. (N.D. Cal. 2005) 415 F.Supp.2d 1018, a Microsoft employee based in Washington signed an employment agreement which included a non-compete clause. This clause contained a Washington choice of law and choice of venue provision.  Immediately after being notified that the employee was leaving to join Google, Microsoft filed suit in Superior Court in Washington.  Shortly thereafter the employee and Google filed suit in Santa Clara Superior Court for a declaration that the covenant to not compete was invalid.  After Microsoft removed the case to federal court, the court elected to stay the action and let the Washington court sort out the choice of law issues.

Although the race to the California courthouse to seek declaratory judgment invalidating a non-compete clause is commonplace, the law may be changing in this regard.  In an unpublished opinion from the Northern District of California, the court dismissed a declaratory action finding a choice of law and choice of forum clause enforceable despite the California action being filed first.  In Meras Engineering, Inc. v. CH2O, Inc. (N.D. Cal., Jan. 14, 2013, C-11-0389 EMC) 2013 WL 14634, two employees had signed an employment agreement which contained a non-compete clause as well as a Washington choice of law and choice of forum provision.  After the employees left to work with a competitor, they filed in California for declaratory judgment that the non-compete provisions were void.  Shortly after, the employer filed suit in Washington state court seeking enforcement of the non-compete provisions.  The court ultimately dismissed the California action without leave to amend and found that applying the Washington forum selection clause would not contravene California public policy because courts in both states would perform the same choice of law analysis. 

Conclusion

Given the complexities associated with the enforcement of non-compete clauses across state lines, it is imperative to consult with an experienced employee mobility lawyer to help navigate these nuanced issues.