Delaware Court Upholds Non-Compete against California Employee

The following is the text of an e-bulletin that I wrote and that was published by the Corporations Committee of the Business Law Section of the California Lawyers Association.N

Patrick Miles, a California resident, was first hired in 2001 by NuVasive, a Delaware corporation doing business in California. He worked in California throughout his employment with the company, ultimately becoming president and a member of the board of directors. In 2016, Miles entered into a new employment agreement with NuVasive.

On October 1, 2017, Miles resigned as a director, officer, and employee; the following day, he joined a competitor of NuVasive as its principal executive officer. Nine days later, NuVasive sued Miles in Delaware alleging, among other things, violation of the covenant not to compete in his employment agreement. Three days after that, Miles and his new employer filed a parallel action in California.

Miles’s employment agreement provided that Delaware law would govern and that any dispute would be litigated in Delaware. The California court granted NuVasive’s motion to stay that action in part and upheld the forum-selection clause requiring litigation in Delaware. Miles then filed a motion for partial summary judgment in the Delaware action on the ground that the covenant not to compete was unenforceable under California law.

Choice-of-Law Issue

The Delaware court noted that the employment agreement between the parties, absent a choice-of-law provision, would be subject to California law and that under California law all covenants not to compete in employment contracts are void. Delaware, on the other hand, enforces reasonable covenants not to compete.

The court observed that if the choice-of-law provision were enforced, the parties would have contractually circumvented California law, and NuVasive could proceed to enforce the covenant not to compete under Delaware law. If California law applied, however, the non-compete provision would be void.

The Delaware court had previously decided a similar matter in Ascension Insurance Holdings, LLC v. Underwood. In that case, the court applied the choice-of-law analysis set out in the Restatement (Second) of Conflict of Laws and concluded that California’s specific policy in favor of freedom of employment prevailed over Delaware’s generalized public policy in favor of freedom of contract. Accordingly, in Ascension, the Delaware court declined to enforce the Delaware choice-of-law provision.

After Ascension was decided, however, California amended the California Labor Code by adding § 925, which provides in pertinent part:

(a)  An employer shall not require an employee who primarily resides and works in California, as a condition of employment, to agree to a provision that would do either of the following:

(1)  Require the employee to adjudicate outside of California a claim arising in California.

(2)  Deprive the employee of the substantive protection of California law with respect to a controversy arising in California.

(b)  Any provision of a contract that violates subdivision (a) is voidable by the employee, and if a provision is rendered void at the request of the employee, the matter shall be adjudicated in California and California law shall govern the dispute.

But § 925(e) exempts contracts where the employee is represented by legal counsel:

(e)  This section shall not apply to a contract with an employee who is in fact individually represented by legal counsel in negotiating the terms of an agreement to designate either the venue or forum in which a controversy arising from the employment contract may be adjudicated or the choice of law to be applied.

The court assumed for purposes of the motion that Miles was represented by counsel in the negotiation of the choice-of-law and forum provisions of the employment agreement. The court noted that Miles’s 2016 employment agreement was entered into before the effective date of Labor Code § 925. In the court’s view, that new provision reflected the current policy of California, even though it was not retroactive to the time Mile’s signed the agreement. The court concluded that it must use the state’s policy as it exists at the time of resolution of the conflict of laws.

The Delaware court found that enactment of Labor Code § 925 resulted in California’s public interest in prohibiting covenants not to compete where the employee is represented by counsel as being weak, in contrast with Delaware’s policy in favor of freedom of contract as being strong. The court then concluded that it would apply Delaware law in ruling on the covenant not to compete.

Comments

An initial question is whether the exception to voidability in Labor Code § 925 has an effect on the enforceability of an employment agreement outside of that code section. Removing a statutory power to void an agreement does not necessarily mean the agreement is otherwise valid and enforceable.

The larger issue is whether the Delaware court made a correct assumption about California law: that the invalidity in California of an employee covenant not to compete is a “substantive protection of California law” intended to protect the employee. In reality, the invalidity in California of covenants not to compete is intended to protect the public as a whole, not just employees per se. It provides that “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” Nothing in Business & Professions Code § 16600 (or in the statutory exceptions at § 16601 et seq.) refers to employees or employers as such or depends on an employment relationship; it applies regardless of the nature of the parties.

Section 16600 is found in Division 7, Part 2, Chapter 1 of the Business & Professions Code. Division 7 is titled “General Business Regulations,” Part 2 is titled “Preservation and Regulation of Competition,” and Part 1 is titled “Contracts in Restraint of Trade.”

In light of this setting and the literal terms of the statute, § 16600 prohibits all agreements in restraint of trade (except as statutorily permitted), not simply employee non-competes. Statutes prohibiting restraints of trade are not intended to protect the parties to anti-competitive agreements; they are intended to protect the public by prohibiting such agreements. Business & Professions Code § 16600 is no less a protection of the public simply because it allows one party to an anti-competitive agreement (an employee) to assert its invalidity as a matter of law. Nothing in Labor Code § 925 states that agreements specifically covered by it can override statutes such as Business & Professions Code § 16600 designed to protect the public.

It is unclear whether the Delaware court took Business & Professions Code § 16600 into consideration in reaching its final outcome, much less the public policy protection nature of it. On the face of the opinion, the court does not seem to have done so. Practitioners focusing on the scope and application of Business & Professions Code § 16600 may have to await further judicial developments to know whether the NuVasive case would have had a different result had the Delaware court considered Business & Professions Code § 16600 directly.

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