WHAT LAW APPLIES TO YOUR NONCOMPETE? DELAWARE COURT UPHOLDS PARTIES’ CHOICE OF LAW PROVISION

Enforcement of noncompete agreements is typically governed by state law, so knowing which state’s law applies is an important question both for drafting and enforcement purposes.  Knowing what law will apply is particularly relevant if any of the parties are located in states which disfavor or even refuse to enforce noncompete agreements (think California).  A recent decision from the Delaware Superior Court may add clarification whether businesses can utilize choice-of-law provisions to increase the enforceability of their noncompete agreements.

A Delaware choice-of-law provision provides that, if litigation arises over the terms of a contract, that the law to be applied to the contract will be Delaware contract law (as opposed to the law of the state where the employer or employee is located).   Delaware follows the Restatement (Second) of Conflicts § 187 which provides that if the contracting parties designate a certain state’s laws to apply:

(2) The law of the state chosen by the parties to govern their contractual rights and duties will be applied, even if the particular issue is one which the parties could not have resolved by an explicit provision in their agreement directed to that issue, unless either:

(a) 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

(b) application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which, under the rule of § 188, would be the state of the applicable law in the absence of an effective choice of law by the parties.

The case of Change Capital Partners Fund I, LLC v. Volt Electrical Systems, LLC, et al., C.A. No. N17C-05-290 RRC (Del. Super. April 3, 2018) involved a plaintiff who brought suit in Delaware Superior Court to enforce a loan agreement and argued that the law of Delaware governed the dispute based on the agreement’s choice of law provision. Defendants in turn argued that New York and Texas applied to the dispute and cited as support the 2015 Delaware Chancery Court case of Ascension Ins. Holdings, LLC v. Underwood.

In the Ascension case, the Court of Chancery held that a non-compete agreement containing a Delaware choice-of-law provision between a California resident and a Delaware LLC based in California was unenforceable since California’s public policy prohibited the use of noncompetes and thus required that California law be applied under Restatement (Second)of Conflicts § 187(2)(b).

The defendants in Change Capital relied upon Ascension to argue that Texas and New York law – not Delaware law –  should apply because the plaintiff was a Delaware LLC headquartered in New York, Defendant Volt was a Texas LLC, Defendant Boudreaux was a Texas resident, and the loan agreement was executed in New York. They asserted that Texas and New York would become the “default state” in the absence of a choice-of-law provision, that the loan would be contrary to public policy of Texas and New York, and that Texas and New York had a materially greater interest in the determination of the agreement. The Superior Court disagreed.

It found that the defendants did not demonstrate that either Texas or New York had a “materially greater interest” than Delaware in the matter.  Furthermore, the Court found that the parties’ agreement established Delaware choice of law, and thus was tied significantly enough to Delaware. Quoting the 2006 case Abry Partners V, L.P. v. F & W Acquisition LLC, the Court noted, “to enter into a contract under Delaware law and then tell the other contracting party that the contract is unenforceable due to the public policy of another state is neither a position that tugs at the heartstrings of equity nor is it commercially reasonable.”

The decision in Change Capital appears to support the proposition that a Delaware choice-of-law provision in a noncompete should be enforced even if the employee resides in a state with laws that disfavors (or even prohibits) such agreements.  While the Superior Court in Change Capital did distinguish the Ascension case because it involved a noncompete agreement, it nevertheless held that it was not enough for the public policy of two states to be conflicting in order to refuse to enforce a contractual choice of law provision. The court held that a party seeking to avoid a choice-of-law provision pursuant to Section 187(2)(b) of the Restatement must demonstrate that the other state has a “materially greater interest in the enforcement or non-enforcement” of the agreement at issue.  In this case, Delaware had a materially greater interest because plaintiff was a Delaware entity and all of the parties agreed to choose Delaware law to control their agreement.

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