Choice of Law and Non-Compete Provisions
This post describes the fascinating interaction between a contract’s choice of law and non-compete provisions in a matter that I worked on.
A longtime client received an acquisition offer from a large, publicly-held company (“Acquirer”). Once the acquisition closed, the client’s founder (“Founder”) would become a management-level employee of Acquirer.
Concern about Non-compete Provision
Although Acquirer’s proposed employment agreement generally was acceptable, Founder was concerned about its non-compete provision. That provision stated that for one year following termination of his employment, Founder would not “engage in any business activities that are competitive with the business activities of [Acquirer] or those of its subsidiary or parent companies”.
The problem was that the business of Acquirer and its affiliates was vast, and Founder’s expertise was industry-specific. In effect, Founder would not be able to work elsewhere.
Acquirer’s General Counsel stated that the non-compete provision was non-negotiable; if Founder did not accept that provision, the acquisition would not take place. In addition, the GC said that even though Founder lived in California and would be working at Acquirer’s offices in California, the New York choice of law provision also was non-negotiable.
Choice of Law Makes a Big Difference
A New York choice of law was potentially bad news for Founder. New York will enforce a non-compete provision if it is no greater than is required for the protection of the legitimate interest of the employer, does not impose undue hardship on the employee, and is not injurious to the public. Furthermore, New York courts are willing to narrow an overly broad non-compete provision to make it enforceable rather than invalidate it entirely. BDO Seidman v. Hirshberg, 93 N.Y.2d 382 (1999)
California, in contrast, generally is hostile to non-compete agreements. Though subject to certain exceptions, California Business & Professions Code Section 16600 states 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”. If California law were to apply, Acquirer’s post-employment non-compete provision would not be enforceable. I looked for a way to bring California law in through the back door.
The agreement stated that any suit relating to the agreement must be brought in New York. I told the General Counsel it was bad enough that the economic disparity between Acquirer and Founder would provide Founder little ability to prevail in any suit against Acquirer. Even worse, requiring Founder to litigate in New York, more than 2,500 miles away, would make it almost impossible for Founder to adequately protect his interests.
California Venue = California Law
I requested that we change that provision to specify that suits must be brought in San Francisco. The GC agreed, so long as New York law still applied. I accepted that requirement. I knew California courts consider Section 16600 such an important part of public policy that they will enforce its prohibition of a non-compete clause even if the agreement specifies that the law of another state will govern! Application Group, Inc. v. Hunter Group, Inc., 61 Cal.App.4th 881 (1998). I don’t know whether the GC was aware of this point, but that was not my concern. Founder liked this approach, the parties signed the agreement, and Founder remains an employee of Acquirer.
I am sharing this story because it shows that, sometimes:
- A choice of law provision matters.
- Applicable law will override a contractual choice of law provision.
- You don’t know whether the other party to a negotiation fully appreciates the significance of his concession, but the best course is to accept the concession and move forward.
Dana H. Shultz, Attorney at Law +1 510-547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.
Choice-of-law, Contracts, Employment, Non-compete
8/26/2009 | 9:54 pm Permalink
I’m in a remarkably similar situation to the Founder you describe above, except that fortunately CA law is applicable in my case.
However, one concern I have is provision 16601 of the web page link you gave in your blog, which seems to state that a non-compete is legal in the sale of a company. To me the key sentence is that the key employees who are involved in an acquisition “may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business so sold, or that of the business entity, division, or subsidiary has been carried on, so long as the buyer…carries on a like business therein.”
Do you have any idea how a California court would interpret the concepts of a “similar business” and a “specified geographic area”? In my case the acquirer manufactures and sells a very specific product in Asia, but my company (which they are acquiring) is located in the bay area (where I currently live).
Any insights you can share would be greatly appreciated. Thanks!
8/26/2009 | 10:46 pm Permalink
California courts will enforce a Section 16601 non-compete provision only if it complies with the statute in all regards. If, for example, there is no geographic area restriction, a court will refuse to enforce the non-compete provision rather than fix it by narrowing the geographic scope – see Strategix v. Infocrossing on the Downloads page. Also, the duration of the non-compete provision must be reasonable perhaps up to three years, but not five or ten. So, if your acquirer does include a non-compete provision, hope that they make the provision too broad (and that they don’t read this blog!).
4/8/2010 | 2:50 pm Permalink
I currently work as a software consultant for a mid-sized company that provides enterprise software for many corporations (including Fortune 500 and SMB) and they are currently requiring all existing employees to sign a non-compete agreement. My supervisor has advised me that I would be terminated for refusing to sign. The agreement is for 3-years and states I cannot work for a competitor, partner company, current customer or prospect company. The agreement also states that it is valid regardless of reason for leaving the company, including layoff (which we have had 5 rounds of layoff over the past year). They are not offering anything in return for signing the agreement (i.e. bonus, options, raise, etc.).
Needless to say, I am very concerned about how to handle this new agreement. If I refuse to sign it, can I legally be terminated for it? And if I do sign it and get laid off, can it prevent me from finding employment in my field?
In my case, the company is headquartered in California and I live in NY.
Any suggestions on how I shuold proceed from here? Thanks!
4/8/2010 | 3:46 pm Permalink
First the standard disclaimer: We have not established an attorney-client relationship, so this does not constitute legal advice.
NY, like most other states, has at-will employment. Absent an express agreement to the contrary, your employment can be terminated at any time for any (non-discriminatory) reason – please see the NYS Department of Labor site at http://www.labor.state.ny.us/workerprotection/laborstandards/faq.shtm#14.
Unfortunately, I cannot answer your question about whether the provision would be enforced because (a) I do not know which state’s law will govern the agreement and (b) not being licensed in NY, I do not know how NY courts treat non-compete provisions. You could consider posting a question (including information about any choice-of-law provision in the agreement) on LinkedIn or Avvo, seeking responses by NY attorneys.
11/20/2010 | 6:41 pm Permalink
We are a couple of teachers, located in CA.
My friend and I just started a tutoring company. We found a campus, where homeschoolers can take classes. We are going to supply classes at this campus. We hired many teachers to do this for us (as we are working during the day right now). We have no idea at this point what kind of documents we need to have our teachers sign. They will be indep. contractors, and we know that we need the 1099 forms for tax purposes.
But our main concern is that our teachers might just go direct with the homeschool campus and contract with them. What can we do to prevent this. Non-compete agreements are illegal in California.
If you can suggest any additional paperwork that we should have them sign, that would be even better:)
Thank you so much!
11/20/2010 | 9:18 pm Permalink
First, the disclaimer: We have not established an attorney-client relationship, and this answer does not constitute legal advice.
You need an independent contractor agreement with each teacher. The appropriate provisions are too numerous to list here.
You have a legitimate basis for requiring that the teachers not steal your homeschoolers. Please see “Don?t Steal Your Former Employer?s Customers” at http://dana.sh/dbohgb.
Trackbacks & Pingbacks
[…] for refusing to enforce non-compete provisions, especially in the post-employment context (see Choice-of-Law and Non-Compete Provisions), so individuals will not be deprived of gainful employment. But provisions limiting competition […]
[…] people know that, when one leaves a job in California, the former employer typically cannot stop the former employee from working for a competitor. However, some people mistakenly believe that the right to compete includes the right to steal the […]
Is a noncompete clause from an English company enforceable in California?…
The non-compete provision will not be enforced in California (though it may be enforceable elsewhere). I was able to take advantage of this fact for a client by negotiating a provision by which any suit to enforce the agreement had to be brought in CA …