Citing Nebraska’s fundamental public policy, the U.S. Court of Appeals for the Third Circuit recently affirmed a District Court’s refusal to enforce a Delaware choice of law clause in a non-compete agreement signed by a Nebraska employee.
Delaware law is generally favorable to enforcing non-compete restrictions. Hundreds of thousands of new corporate entities (corporations, LLCs, LPs, LLCs, etc.) are created in Delaware every year, and the First State is home to more than two-thirds of the Fortune 500 and 80 percent of all firms that go public.[1] Many of these Delaware entities are headquartered in, and have operations in, states with less favorable non-compete law than Delaware. Choosing Delaware law to govern non-compete restrictions thus seems like a bullet-proof strategy for side-stepping unfavorable state law and enforcing non-compete restrictions. However, a Delaware choice of law clause does not guarantee enforcement.
As we recently reported, incorporation (or formation) in Delaware is a legally sufficient basis for choosing Delaware law to govern non-compete restrictions – even if the employer is headquartered in another state and the employee works in another state.[2] Stated differently, and in terms of the Restatement (Second) of Conflicts of Laws (“Restatement”), incorporation or formation in Delaware by itself creates a “substantial relationship” with Delaware. Restatement § 187(2)(a).
But that does not end the choice of law inquiry. A Delaware choice of law clause will not be enforced if application of Delaware law is “[1] contrary to a fundamental public policy of a state which [2] has a materially greater interest than the chosen state in determination of the particular issue and which [3] would be applicable law in the absence of an effective choice of law by the parties.” Restatement § 187(2)(b). In the situation we’re discussing – i.e., the only connection to Delaware is the employer’s incorporation or formation there – the state where the employee works will have a materially greater interest in the dispute than Delaware, and would be the applicable law in the absence of the choice of law clause. Validity of the Delaware choice of law clause thus rises or falls on whether Delaware law is contrary to a public policy of the state in which the employee works.
In Cabela’s LLC v. Higby, 362 F. Supp. 3d 208 (D. Del. 2019), the court had to decide the validity of a Delaware choice of law provision where the employee lived and worked in Nebraska. Nebraska non-compete law is more restrictive that Delaware law. The court explained that Nebraska non-competes may “restrain competition by improper and unfair methods, but may not constrain ordinary competition,” while in Delaware “[a]n agreement prohibiting ordinary competition is enforced so long as it is not oppressive to an employee.” Id. at 217-18 (citations omitted). The court found that the non-compete at issue restrained ordinary competition, and was therefore unenforceable under Nebraska law, but would be enforceable under Delaware law. The court therefore held that “the application of Delaware law would be contrary to a fundamental policy of Nebraska,” and refused to enforce the Delaware choice of law clause. Id. at 219.
The mere fact that an agreement is enforceable in one state but not another is not necessarily dispositive of the contrary-to-a-fundamental-policy issue. However, the Third Circuit recently affirmed the district court’s decision. In doing so the Third Circuit specifically refused the employer’s request to certify the question to the Delaware Supreme Court, noting that “we do not find the law to be unsettled on this point.” Cabela’s LLC v. Higby, 2020 WL 1867922, at *1 n.8 (3d Cir. April 14, 2020).[3]
Practitioners, particularly those who advise their corporate colleagues on mergers and acquisitions, often review employment agreements that contain Delaware choice of law provisions. These practitioners are entirely correct in telling their corporate colleagues and clients that Delaware non-compete law is generally favorable to the employer. However, the careful practitioner will also add that enforceability may ultimately depend on where the employee works.
[1] https://corp.delaware.gov/stats/
[2] https://www.tradesecretsandemployeemobility.com/2020/04/articles/non-compete-agreements/first-circuit-massachusetts-employee-must-abide-by-a-restrictive-covenant-governed-by-a-delaware-choice-of-law-clause-the-more-things-change-the-more-they-stay-the-same-part-ii/
[3] https://www2.ca3.uscourts.gov/opinarch/191423np.pdf
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