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.

Check out:

• All posts about choice of law
• All posts about non-compete provisions

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.