Court Rejects Delaware Choice of Law Provision in Refusing to Enforce Customer Non-Solicitation Covenant Against California Employee

On August 26, 2019, the Delaware Chancery Court invalidated a California employee’s customer and employee non-solicitation covenant on the grounds that it violated California law. In doing so, the Court rejected the plaintiff company’s attempt to override California law by including a Delaware choice of law provision in the underlying agreement.

Background

We initially reported on the case of NuVasive v. Miles, Case No. 2017-0720-SG, on December 10, 2018, after the Chancery Court denied the defendant employee’s original motion for partial summary judgment. NuVasive, a Delaware corporation with headquarters in California, hired Miles as an executive-level employee in California. Upon his hiring, Miles entered into an employment agreement with Nuvasive containing a non-competition covenant as well as both customer and employee non-solicitation covenants. The agreement also included Delaware choice of law and choice of forum provisions.

When Miles resigned and joined a competitor, NuVasive sued in Delaware to enforce the non-competition and non-solicitation covenants. In response, Miles alleged that the restrictive covenants, as well as the choice of law and choice of forum provisions, were unenforceable under California law.

Court Initially Upholds Delaware Choice of Law Provision

In its order dated September 28, 2018, covered in our original article, the Chancery Court examined the validity of the agreement’s Delaware choice of law provision, asking:

      • Would another state’s laws apply in the absence of a choice of law provision?
      • If so, would enforcing the non-compete covenant violate a fundamental public policy of that other state?
      • If so, are the other state’s applicable public policy interests materially greater than the applicable public policy interests of Delaware?

Because Miles resided, worked, and sought to compete in California, the Chancery Court determined that the restrictive covenants would normally be subject to California law in the absence of a choice of law provision. The court further held that enforcement of the non-compete covenant under Delaware law would violate California’s fundamental public policy interests in light of: (1) Section 16600 of the California Business and Professional Code, which strictly prohibits all restraints on competition in the employment context; and (2) Section 925 of the California Labor Code, which prohibits choice of law or choice of forum provisions that circumvent California’s statutory protections or restrict access to a California judicial forum. The court declined at the time to render a judgment about the customer and employee non-solicitation covenant, due to the lack of clarity about whether such covenants also were prohibited under Cal. Bus. & Prof’l Code Section 16600.

As for the third question, the Chancery Court held in the initial order that California’s public policy interests against the enforcement of non-compete covenants did not outweigh Delaware’s own public policy interests favoring freedom of contract. The court based its conclusion on the assumption that Miles negotiated the employment with the assistance of counsel. Although California Labor Code Section 925 generally prohibits parties from contracting around California substantive laws and California judicial forums, it carves out an exception with respect to employees who are represented by their own legal counsel during the contract negotiations. By that carve-out, the court reasoned, the California Legislature recognized “that in the limited subset of cases where the inequality of bargaining strength of the parties to an employment contract is buffered by the employee being represented by independent counsel, and where counsel participated in negotiation of the terms of a choice of law provision, California’s interest in freedom of contract outweighs interest in freedom of employment.”

Court Reverses Course and Rejects Restrictive Covenants under California Law

Notwithstanding the court’s September 28, 2018 order, Miles subsequently submitted sufficient evidence to persuade the court that he had not, in fact, been represented by counsel during the negotiation of the employment agreement. With these facts, on June 7, 2019, the court reversed its earlier decision and held that the non-compete covenant was subject to and invalid under California law.

Although the court invalidated only the non-compete covenant in its June 7, 2019 order, it requested further briefing from the parties as to whether the non-solicitation covenant also was contrary to California public policy. In the August 26, 2019 order, the court answered that question in the affirmative.

In reaching this conclusion, the Chancery Court noted that California courts have classified customer and employee non-solicitation covenants as “restraints” on competition, even if they fall short of prohibiting competition entirely. The Chancery Court pointed to the California Supreme Court decision in Edwards v. Arthur Anderson LLP, 189 P.3d 285, 292 (Cal. 2008), which held that a restriction on one’s ability to perform work for certain clients constitutes an invalid restraint on competition under Cal. Bus. & Prof’l Code Section 16600. More recent decisions have applied similar reasoning to invalidate employee non-solicitation covenants, although the case law regarding employee restrictions is less settled.

The Chancery Court’s decision hinged on its refusal to honor the parties’ contractual choice of law, based on California Labor Code §925. Oddly, however, Miles signed his employment agreement containing the Delaware choice of law and forum provisions in 2016, before the effective date of California Labor Code §925. It is unclear whether such an argument might have impacted the Chancery Court’s decision.

Conclusion

In summary, the Chancery Court held that Miles’ non-compete and non-solicitation covenant were both void under California law, and, therefore, enforcement of the covenants would be contrary to California public policy. Moreover, NuVasive could not invoke the employment agreement’s Delaware choice of law and choice of forum provisions to circumvent California’s ban on such covenants because Miles had not retained an attorney to assist in the negotiation of the agreement. As such, the court dismissed NuVasive’s breach of contract claims.

As this case highlights, employers should be careful when attempting to enter into restrictive covenant agreements with California employees, and should always do so with the assistance of an experienced non-compete attorney. This case also shows that it can be to the employer’s interest to ensure that the other party has legal representation, in certain circumstances.

Companies needing assistance in the drafting of restrictive covenants are encouraged to contact a Jackson Lewis attorney for further guidance.

Virginia Attempts, Maryland Succeeds, in Limiting Non-Competes For Low-Wage Employees

In numerous states throughout the country, legislatures are moving to limit the use and enforcement of non-compete and other restrictive covenant agreements. Two such states, Maryland and Virginia, are seeking to curtail such agreements with regard to low-wage employees.

Virginia Senate Bill 1387

On January 17, 2019, the Virginia Senate introduced SB 1387, which would prohibit employers from “enter[ing] into, enforc[ing], or threaten[ing] to enforce a covenant not to compete with any low-wage employee.” A “low-wage employee” is defined as one who earns less than the average weekly wage of the Commonwealth,[1] and includes interns, students, apprentices, and trainees, whether or not they are being paid for their work, as well as some independent contractors.[2]

Senate Bill 1387 also would prohibit covenants not to compete that “restrict an employee from providing a service to a customer or client [whom] the employee does not initiate contact with or solicit[.]” A covenant not to compete is broadly defined as an agreement “between an employer and employee that restrains, prohibits, or otherwise restricts an individual’s ability, following the termination of the individual’s employment, to compete with the former employer.”

In addition to banning non-competes for low-wage employees, the bill would establish a private right of action for low-wage employees against any former employer (or other person) who attempts to enforce a prohibited agreement. An affected employee must commence the action within two years of the latter of: (1) the date the agreement was signed, (2) the date the low-wage employee learned of the agreement, (3) the date the employment relationship was terminated, or (4) the date the employer attempted to enforce the agreement. In addition to authorizing awards of injunctive relief, compensatory damages, liquidated damages and costs and attorney fees, Senate Bill 1387 would require courts to assess a civil penalty against culpable employers in the amount of $10,000 for each violation.

Additionally, all employers would be required to post a copy of the Bill (or an approved summary) ”in the same location where other employee notices required by state or federal law are posted.” Violations of this requirement would subject employers to penalties of escalating severity (written warning for first violation; civil penalty of up to $250 for second violation; and civil penalties of up to $1,000 for each subsequent violation).

On February 12, 2019, the Senate Committee on Commerce and Labor designated SB 1387 as “passed by indefinitely.” As of the current date, it is unclear whether the Committee will give it further consideration.

Maryland Senate Bill 328

On January 30, 2019, the Maryland Senate initiated a similar effort when it introduced SB 328. Less than four months later, after passing the Senate and House, the bill took effect without the Governor’s signature.

At first glance, MD 328 appears far more restrictive than VA SB 1387, as it declares all “noncompete [provisions] that restrict[] the ability of an employee to enter into employment with a new employer or to become self-employed in the same or similar business or trade” as “null and void as being against the public policy of the State.” However, the introductory section makes clear that the non-compete ban only applies “to an employment contract or a similar document or agreement concerning an employee who earns equal or less than […]$15.00 per hour; or […] $31,200 annually[.]” Although the Bill does not clarify whether it applies to restrictive covenants that fall short of prohibiting competition, such as customer non-solicitation covenants, it expressly excepts from its coverage any “employment contract[s] or similar document[s] or agreement[s] with respect to the taking or use of a client list or other proprietary client-related information.”

In contrast to VA SB 1387, which stalled out in committee, MD SB 328 passed both the House and Senate on April 5, 2019. Pursuant to Maryland’s Constitution, Governor Larry Hogan was required to sign or veto the bill by May 25, 2019, or else do nothing and allow it to become law automatically. Ultimately, Governor Hogan chose the latter option, and the Bill automatically became law, subject to an effective date of October 1, 2019.

In summary, while the Virginia Legislature has not acted to advance SB 1387, Maryland has enacted its own ban on non-competes for low-wage employees. We will continue to follow the Virginia bill and will update readers on any developments. Employers needing assistance in complying with the non-compete laws of the states in which they operate are encouraged to contact a Jackson Lewis attorney for further guidance.

[1] The average weekly wage is determined by the Virginia Employment Commission (the “Commission”) by adding the total wages (excluding wages of U.S. government employees) reported on contribution reports to the Commission for the 12-month period ending the preceding June 30 and divided by the average monthly number of insured workers and then divided by 52. In March 2018, for example, the average weekly wage in Virginia was $1,152.

[2] Low-wage employees include independent contractors who are paid at an hourly rate that is less than the median hourly wage for the Commonwealth of Virginia for all occupations as reported, for the preceding year, by the Bureau of Labor Statistics of the U.S. Department of Labor. In May 2017, for example, the median hourly wage for the Commonwealth of Virginia for all occupations was $19.13.

Trade Secrets – Courts Won’t Protect You If You Don’t Protect Yourself!

A decision from the Northern District of Illinois is the latest to reiterate a stern warning we have long highlighted for employers: when insufficient steps are taken by an employer to protect its own proprietary information, courts will not provide trade secret protection when such information is misappropriated.

In Abrasic 90 Inc. v. Weldcote Metals, Inc., No. 18-cv-05376 (N.D. Ill. March 4, 2019), the plaintiff-company Abrasic 90 Inc. (“Abrasic”), a manufacturer of abrasives products, sued several of its former employees (including its former president) and a competing company they formed, Weldcote Metals, Inc. (“Weldcote”), for misappropriation of its trade secrets in violation of the federal Defend Trade Secrets Act of 2016 and the Illinois Trade Secret Act. Abrasic alleged its former president retained a flash drive from his employment with Abrasic that contained “a comprehensive summary of [Abrasic’s] transactional information, including sales data, prices, and costs for its products and the identities of its suppliers and distributors.” Abrasic also claimed that the other individual defendants possessed similar information to be used in their subsequent employment with the competing company. In addition to demanding monetary damages, Abrasic sought to enjoin Weldcote and the individual defendants from using the information at issue in the competing enterprise, as well as from doing business with Abrasic’s suppliers and distributors.

The Court denied Abrasic’s motion for a preliminary injunction, however, finding that Abrasic could not show that its information warranted trade secret protection. The Court chose this matter to reiterate a valuable—albeit sometimes painful—lesson for employers: if you don’t protect your trade secrets, neither will the courts.

The Court recounted the well-known rule that for information to be considered a trade secret, it must have been “sufficiently secret to impart economic value because of its relative secrecy,” and “reasonable efforts to maintain the secrecy of the information” must have been taken. The Court found the first factor was satisfied for purposes of the motion, because the information purportedly misappropriated consisted of business and financial information, and was compiled in such a manner that it would “require substantial time, effort, and expense to recreate the compilation.” But the Court held that Abrasic failed to establish the second factor because it “took almost no measures to safeguard the information that it now maintains was invaluable to its competitors.” The Court gave a litany of suggested steps that employers can and should take to protect their proprietary information sufficient to cloak such information with trade secret protection, including:

  • Requiring those with access to trade secrets to enter into non-disclosure and confidentiality agreements;
  • Establishing and implementing policies concerning the confidentiality of the company’s business information, including specifying the categories of information deemed by the company to be confidential;
  • Training company employees about their obligation to keep such categories of information confidential;
  • Ensuring all confidential information is returned to the company upon the cessation of employment of any employee with access to such information;
  • Ensuring that company employees with responsibility for maintaining sensitive company data and information are trained on data security, and that the company maintains and implements comprehensive data security policies and practices;
  • Restricting access to sensitive company information to employees on a need-to-know basis, such as giving employees a one-time-only password to access the information; and
  • Differentiating access to sensitive company information from access to non-sensitive company information.

While an employer does not necessarily need to take all of these example measures to confer trade secret protection, Abrasic allegedly failed to establish that it effectively implemented any such measures.  About the only protective measure Abrasic took, according to the Court, was to require some employees with access to the alleged proprietary information to agree to maintain its secrecy.  However, even that measure was ineffective, because Abrasic provided the same access to other employees and independent contractors without imposing similar conditions of non-disclosure.  Therefore, the Court held that the company could not show that its claims had a likelihood of success—dooming its preliminary injunction motion.

As this decision confirms, employers cannot rely on the courts to protect their valuable trade secrets, unless they have done their job to minimize the potential for misappropriation. To ensure that you are taking the appropriate steps to safeguard your trade secrets and confer protection in the courts, please contact a member of Jackson Lewis’s Non-Competes Practice Group.

Washington Governor Signs Non-Compete Law

On May 8, 2019, Washington Governor Jay Inslee signed into law HB 1450, described as “AN ACT Relating to restraints, including noncompetition covenants, on persons engaging in lawful professions, trades, or businesses[.]”  While the Act does not take effect until January 1, 2020, its restrictions apply retroactively to existing agreements signed before that date.

Our article discussing the law, which was posted just as Governor Inslee was signing the bill, can be found here.  Companies with questions about how to comply with the new law are encouraged to contact a Jackson Lewis attorney for further guidance.

Washington State Legislature Sends Comprehensive Non-Compete Bill To Governor’s Desk

On April 26, 2019, the two chambers of the Washington Legislature passed Engrossed Substitute House Bill 1450 (“HB 1450” or the “Non-Compete Act”), which regulates non-competition agreements with employees and independent contractors, and severely restricts franchisee no-poach agreements as well as policies against moonlighting. Governor Inslee is expected to sign the Act, which would take effect on January 1, 2020.

Introduction

Under the new law, a non-competition covenant would be void and unenforceable unless it meets the following conditions:

  • If the covenant is entered into at the commencement of employment, it must be disclosed in writing to the employee by no later than the time the employee accepts the offer of employment;
  • If the covenant is entered into at the commencement of employment but will not take effect until a later date due to foreseeable changes in the employee’s compensation, it must specifically disclose that it may be enforceable in the future;
  • If the covenant is entered into after the commencement of employment, it must be supported by additional consideration;
  • The worker’s annual earnings must exceed $100,000 in the case of an employee, or $250,000 in the case of an independent contractor (based upon the income reflected in Box 1 of an employee’s IRS Form W-2 or an independent contractor’s IRS Form 1099);
  • If the employee is laid off, the employer must continue paying “compensation equivalent to” his or her base salary (minus income from subsequent employment) during the period of enforcement; and
  • The covenant must have a post-separation duration of no more than 18 months, unless the employer can show clear and convincing evidence that a longer duration is necessary to protect its business or goodwill.

In addition to the above requirements, the new law includes the following key provisions:

Definition of Non-Competition Covenants

As defined under the law, the term “non-competition covenant” expressly excludes employee and customer non-solicitation covenants, confidentiality/non-disclosure covenants, and covenants relating to the purchase or sale of a business or franchise. To take advantage of these exclusions, employers should separate non-competition covenants from all other provisions, take extra care to narrowly draft the scope of non-competition terms on a case-by-case basis, and make sure to include severability clauses. Employers can also consider other types of agreements, such as those requiring employees to repay training expenses and other expenses if they leave a job before a specified period of time.

Adjustable Earnings Thresholds

The minimum salary thresholds of employees and independent contractors are adjusted each year for inflation. This adjustment may complicate enforcement of non-competition agreements continuing from one year to the next, because agreements that are initially enforceable may become invalid in subsequent years if pay increases do not keep up with inflation. Further, if an agreement becomes enforceable only at a date later than the commencement of employment, the employer must “specifically disclose[] that the agreement may be enforceable against the employee in the future.” This provision allows employers to require employees making less than the salary threshold to sign a non-competition agreement before it actually becomes enforceable.

No-Poach Agreements

In a diversion from non-competes, HB 1450 also bans anti-raiding provisions in vertical franchise agreements. Under Section 7 of the Act, “[n]o franchisor may restrict, restrain, or prohibit in any way a franchisee from soliciting or hiring any employee of” either the franchisor or another franchisee of the same franchisor. This provision furthers a concerted effort by the Washington State Attorney General to put an end to such practice, as addressed in our article dated August 22, 2018.

Moonlighting

In addition to the no-poach ban, the Act also veers away from non-competition covenants to crack down on moonlighting restrictions. Section 8 of the Act provides that an employer may not prohibit an employee earning less than twice the state minimum wage from having another job, unless the prospective moonlighting work raises legitimate concerns regarding safety, scheduling, and/or conflicts of interest.

Choice of Law or Venue Provisions

Under the new law, parties are prohibited from agreeing to litigate non-compete disputes outside of Washington, or from otherwise circumventing “the protections or benefits of” the law. HB 1450 would void any provision that violates that prohibition.

Remedies

Where an employer is alleged to have violated the Non-Compete Act, HB 1450 authorizes the State Attorney General as well as the aggrieved employee to initiate enforcement action. If such enforcement action is successful, the aggrieved employee is entitled to recover the greater of his or her actual damages or a statutory penalty of $5,000.00, plus attorneys’ fees, expenses, and costs. Further, while HB 1450 permits judicial modification or “blue penciling” of an overly broad non-competition covenant, such measures do not absolve the employer of liability for the above-referenced monetary payments.

Retroactive Application

Importantly, the Non-Compete Act applies retroactively to any active non-competition covenants entered into prior to January 1, 2020, subject to two caveats. First, the Non-Compete Act does not apply to any legal proceedings commenced prior to January 1, 2020. Second, “[a] cause of action may not be brought regarding a noncompetition agreement signed prior to the effective date of this section if the noncompetition covenant is not being enforced.”

With sweeping changes to existing state law, the Non-Compete Act will have a significant impact on companies operating in Washington. For assistance in responding to the potential passage of the bills, or to ensure compliance with the non-compete laws of other states, please contact a Jackson Lewis attorney.

Utah Amends Three-Year-Old Non-Compete Law For Second Time In Two Years

After enacting its non-compete law on April 7, 2016, Utah has twice amended the law to address additional restrictions on non-competes in the broadcasting industry. Governor Gary Herbert signed the second of those amended bills on March 22, 2019.

The Original Non-Compete Law

Utah’s original non-compete law, which we covered in an article dated April 7, 2016, imposed a one-year post-employment time limit on non-competes, except where the non-competes were part of a severance agreement or where they related to or arose out of the sale of a business.   The law also authorized employees to seek damages and attorney’s fees against employers who attempted to enforce invalid non-competes.

The 2018 Amendment

On March 27, 2018, the State amended its non-compete law to impose special restrictions with respect to employees in the broadcasting industry (see our related article, dated April 2, 2018). Specifically, the 2018 amendment provided that, for a non-compete agreement to be enforceable against an employee of a broadcasting company, the company had to establish the following elements:

  • The employee was paid a salary of at least $913 per week (i.e., $47,476 per year);
  • The covenant was part of a written employment contract of no more than four years; and
  • The employee was either terminated “for cause” or had breached the employment contract “in a manner that results in” his or her separation of employment.

In addition, the 2018 amendment prohibited non-competes from extending beyond the original term of the employee’s written contract.

The 2019 Amendment

On March 22, 2019, Governor Herbert signed into law House Bill 199, making a limited change to the provision on broadcasting employees. Specifically, the new law focuses on the year-old requirement that a non-compete in the broadcasting industry must be part of a written contract of no more than four years in duration in order to be valid. Eliminating the four-year written contract requirement, the law now provides that the non-compete must be “part of a written contract of reasonable duration, based on industry standards, the position, the broadcasting employee’s experience, geography, and the parties’ unique circumstances.”

There appears to have been limited media reporting regarding the newest amendment. However, legislators presumably believed the hard, four-year cap on written contract durations did not reflect the realities of the broadcasting industry. Consequently, the new law gives judges more leeway to evaluate the unique circumstances of individual parties, before determining whether a non-compete agreement is reasonable and enforceable.

Companies with questions about the enforceability of restrictive covenants in their jurisdictions are encouraged to contact a Jackson Lewis attorney for further guidance.

U.S. Senators Seek Formal Investigation Of Non-Compete Use And Impact

Earlier this month, a group of six United States Senators made a joint request for the Government Accountability Office (GAO) to investigate the impact of non-compete agreements on workers and the U.S. economy as a whole. This action suggests that the federal non-compete reform effort is not going away.

Recent Legislative Efforts

On February 18, 2019, we reviewed a new bill by Florida Senator Marco Rubio to prohibit non-competes for low-wage employees. That bill followed an effort in 2018 by Democrats in both houses of Congress to ban non-competes altogether. Although Senator Rubio’s bill represents a more limited attack on non-competes, we noted that it “suggests a level of bipartisan support that was not previously apparent.”

The Joint Letter

The recent joint letter to the GAO, issued on March 7, 2019, is signed by two Senators who were not involved in the prior legislative efforts: Democratic Senator Tim Kaine (VA); and Republican Senator Todd Young (IN). This represents additional evidence of bipartisanship on non-compete reform.

The joint letter does not formally oppose the use of non-competes. Nevertheless, from the Senators’ explanation for their request, it is clear that they believe the use of non-competes has become excessive, and that significant harm is being done to workers and the greater economy as a result.

In the letter, the Senators cite three ways in which non-competes allegedly are being abused:

  • The allegedly excessive imposition of non-competes on low-wage workers;
  • The alleged inability of workers to “engage in genuine negotiation over these agreements”; and
  • The belief that “most working under a non-compete were not even asked to sign one until after receiving a job offer.”

Further, the Senators allege that “[a]cademic experts and commentators from across the political spectrum have raised serious concerns about the use and abuse of these clauses[.]”

Based on the above-referenced concerns, the letter instructs the GAO to investigate the following questions:

  • What is known about the prevalence of non-compete agreements in particular fields, including low-wage occupations?
  • What is known about the effects of non-compete agreements on the workforce and the economy, including employment, wages and benefits, innovation, and entrepreneurship?
  • What steps have selected states taken to limit the use of these agreements, and what is known about the effect these actions have had on employees and employers?

Of note, these questions appear to address broader concerns about the use and impact of non-compete agreements than the discreet issues raised by the alleged “abuses” set forth above. The letter does not provide a deadline for the GAO to issue its report. However, the GAO’s explanation of how it handles investigation requests sets forth a six-step process, from Congress making the request to the issuance of the report. Further, while the GAO protocol does not offer a time-frame for every step, it does state that it “typically” takes “about 3 months” to simply design the scope of the investigation. Consequently, it would be reasonable to anticipate waiting months at least for the GAO to issue the report.

Where Does This Leave Us?

As noted above, the joint letter indicates that there is growing bipartisan support for restricting the use of non-competes on a nation-wide level. At the same time, by expressing the need for additional information about the use and impact of non-compete agreements on U.S. workers, the Senators may not move forward with further proposed non-compete legislation until they receive that information and take the time to fully digest its implications.

Employers with questions about the enforceability of restrictive covenants, including at the state level, are encouraged to contact a member of Jackson Lewis’s Non-Competes and Protection Against Unfair Competition Practice Group.

New Jersey Court Offers A Reminder That The Duty Of Loyalty Is Thicker Than Ink

Do employees in New Jersey owe a duty of loyalty to employers, even without a written employment agreement? Eliminating any possible doubt, the New Jersey Appellate Division answered, emphatically, yes.

In Technology Dynamics, Inc. d/b/a Nova Battery Systems v. Emerging Power, Inc. et al., Docket No. A-0952-17T3 (N.J. Sup. Ct. – App. Div. Feb. 26, 2019), the Appellate Division reinstated breach of duty of loyalty claims against two former key employees of Nova Battery Systems (“NBS”), Master and Beringer, who resigned from NBS to work at competitor Emerging Power, Inc. (“EPI”). In an eleven-count complaint, NBS asserted a number of claims, including counts for breach of duty of loyalty and tortious interference with prospective business, and sought injunctive relief – which was denied.

Notably, Master and Beringer did not have any employment contract or non‑compete agreement with NBS. Consequently, at the conclusion of the discovery period, EPI moved for summary judgment, based partly on the contention that NBS’s claims could not survive the absence of a written contractual agreement. The trial court agreed and dismissed the complaint.

On appeal, NBS argued that a written agreement is not required in order to establish claims of breach of the duty of loyalty and tortious interference. The Appellate Division agreed and issued a twenty-five page opinion tracing the history of the duty of loyalty claim.

The Court noted the 2001 New Jersey Supreme Court decision in Lamorte Burns & Co., Inc. v. Walters, 167 N.J. 285, 302 (2001), for the fundamental proposition that, contract or no contract, “[a]n employee must not while employed act contrary to the employer’s interest.” After acknowledging that an employee has the right to make preparations to start a competing business, the Court reminded us, by citing to the New Jersey Supreme Court decision in Cameco, Inc. v. Gedicke, 157 N. J. 504, 517 (1999), that “the employee may not breach the undivided duty of loyalty he or she owes to his or her employer while still employed by soliciting the employer’s customers or engaging in other acts of secret competition.”

The Cameco decision identified the following four-factor analysis relevant to determine whether an employee breached a duty of loyalty:

(1) The existence of contractual provisions relevant to the employee’s actions;

(2) the employer’s knowledge or, or agreement to, the employee’s actions;

(3) the status of the employee and his or her relationship to the employer, e.g. corporate officer or director versus production line worker; and

(4) the nature of the employee’s [conduct] and its effect on the employer.

Kaye v. Rosefielde, 223 N.J. 218, 230 (2015) (alteration in original) (citing Cameco, 157 N.J. at 521-22).

The Court noted that while the existence of a contract is a relevant factor to be considered in a breach of the duty of loyalty claim, it is not determinative. In reviewing the evidentiary record, the Court noted emails showing Master and Beringer intended to solicit their NBS customers while they were still employed by NBS. The emails further indicated that Master and Beringer planned to sell those customers an excess amount of NBS products before resigning their employment, so that the customers could manage any delays in servicing during the transition from NBS to EPI.

Therefore, relying on Lamorte – for the proposition that an employee may not breach the undivided duty of loyalty he or she owns to his or her employer while still employed by soliciting the employer’s customer or engaging in other acts of secret competition – the Appellate Division reversed the trial court decision and restored the breach of duty of loyalty and tortious interference counts of the Amended Complaint. This decision reminds us that breach of duty of loyalty claims are alive and well in New Jersey, and do not sink or swim on the existence of a written contract.  Nevertheless, there are many reasons why an employer concerned about competition by former employees ought to use some form of restrictive covenant agreement.

Companies needing assistance in non-compete matters or drafting restrictive covenant agreements are encouraged to contact a Jackson Lewis attorney for related guidance.

U.S. Senator Reignites Federal Non-Compete Reform Efforts With Bill Aimed At Protecting Low-Wage Employees

Last year, Democrats in the United States Senate and House of Representatives introduced bills — S.2782  and H.R.5631 — banning non-compete agreements in the vast majority of workplaces across the country. Although those bills failed to gain traction, the authors of this Blog anticipated a renewed effort at federal non-compete reform in 2019, with Democrats taking control of the House in the November 2018 elections. Sure enough, the Federal Freedom to Compete Act  (the “Act”) was introduced on January 15, 2019, but in a twist, the Act’s author is not a Democrat but rather Marco Rubio, Republican Senator from the State of Florida.

As explained on Senator Rubio’s website, the Act is focused on “entry-level, low-wage workers” and is designed to “empower these workers by preventing employers from using non-compete agreements in employment contracts.” Below, we take a closer look at the Act, including the types of agreements covered by the Act, as well as the scope of employees who would be subject to its protections.

Introduction

Drafted within the framework of the Fair Labor Standards Act (“FLSA”), the Act prohibits employers from entering into, extending, renewing, enforcing, or threatening to enforce “non-compete agreements” with respect to all employees except for FLSA-exempt executive, administrative, professional, or outside sales employees. Notably, this prohibition would apply retroactively to any agreements entered into prior to the Act’s enactment. Employers who violate such provisions “shall be liable for such legal or equitable relief as may be appropriate to effectuate the purposes of such section.”

What is a “non-compete agreement”?

As defined in the Act, a “non-compete agreement” means an agreement between an employer and employee “that restricts such employee from performing, after the employment relationship […] terminates …: (1) Any work for another employer for a specified period of time[;] (2) Any work in a specified geographical area[; or] (3) Any work for another employer that is similar to such employee’s work for the employer that is a party to such agreement.” In addition to this general definition, the Act expressly states that it does not preclude agreements that prohibit the disclosure of trade secrets.

We see three primary issues with this definition:

First, while it is true that most non-competes are limited to a specified duration, geographic range, and type of work, that is not always the case. Interpreted in its most literal sense, the Act does not account for restraints on competition that, intentionally or not, fail to include such specifications. For instance, an agreement that simply prohibits an employee from subsequently working for a competing business, while potentially overbroad and unenforceable on other grounds, would fall outside of the above-referenced definition and, therefore, would theoretically avoid coverage under the Act. The creation of this loophole was presumably unintentional.

Second, by defining “non-compete agreements” to include agreements that restrict work “for another employer” for a specified duration or in a specified capacity, the Act seemingly fails to cover agreements that prevent an employee from competing in a capacity other than as an employee (e.g., where an employee forms a competing business or works for a competitor as an independent contractor). Again, this distinction was presumably unintentional.

Third, while the Act expressly disclaims coverage over agreements that prohibit the misappropriation of trade secrets, it is unclear whether it applies to the use of limited restraints on competition, such as covenants that prohibit the solicitation of employees, the solicitation of customers, or the disclosure of confidential information that does not qualify as a trade secret.

Who does the Act protect?

As mentioned above, the primary intent of the Act is to increase the economic freedom of “entry-level, low-wage workers.” In order to meet that goal, the Act initially imposes a broad prohibition on non-compete agreements for all employees. The Act then adds the caveat that the prohibition “shall not apply with respect to any employee described in [FLSA] section 13(a)(1)[,]” which includes exempt executive, administrative, professional, and outside sales employees who meet heightened wage requirements.

By allowing non-compete agreements only for exempt executive, administrative, professional, and outside sales employees, one could safely argue that the Act’s non-compete ban extends to employees who are neither “entry-level” nor “low-wage.” At the same time, the Act would prohibit the use of non-compete agreements with anyone who is paid on an hourly basis. Consequently, as the Act gets increased attention, there will likely be efforts from pro-business forces to narrow the scope of the ban.

Conclusion

In light of last year’s Democrat-led efforts to regulate non-compete agreements at the federal level, Senator Rubio’s submission of the Federal Freedom to Compete Act suggests a level of bipartisan support that was not previously apparent. We will continue to monitor the Act to determine the extent of that support. Employers with questions about the enforceability of their restrictive covenants are encouraged to contact a member of Jackson Lewis’s Non-Competes and Protection Against Unfair Competition Practice Group.

Delaware Court Grapples With Enforcement of Choice of Law Provisions in Restrictive Covenant Agreements

When implementing restrictive covenant agreements in their workforces, companies often grapple with how best to handle the wide variation in the law from one state to the other. One solution is to include a choice of law provision that calls for all agreements to be construed under the laws of a single state. Still, there is no guarantee that courts will honor a choice of law provision, particularly where the purpose of the agreement conflicts with the public policy interests of a different state that shares an interest in the subject matter at issue.

Twice in recent months, the Delaware Chancery Court addressed the enforceability of Delaware choice of law provisions in restrictive covenant agreements involving out-of-state employees. In Cabela’s LLC v. Wellman et al., Case No. 2018-0607-TMR (Oct. 26, 2018), the plaintiff, a Delaware corporation with headquarters in Nebraska, sued four former director-level employees from its Nebraska headquarters. Meanwhile, the plaintiff in NuVasive, Inc. v. Miles, Case No. 2017-0720-SG (Sept. 28, 2018) was also a Delaware corporation but with business operations in California, and was suing to enforce a non-compete agreement against a similarly high-level employee in California. In both Cabela’s and NuVasive, the defendant employees resided, worked, and ultimately sought to compete with their former employers in Nebraska and California, respectively. In other words, virtually all relevant activities at issue in the cases occurred outside of Delaware. Nevertheless, the plaintiff former employers asked the Court to enforce their agreements under Delaware law, based on their inclusion of Delaware choice of law provisions in the relevant agreements.

While Delaware courts generally honor contractual choice of law provisions, the Court noted an important public policy exception to that rule. As the court explained in Cabela’s, “[w]here the parties enter a contract which, except for the choice of law provision, would be governed by the law of a [different] state, and that state has a public policy under which a contractual provision would be limited or void, the Restatement recognizes that allowing the parties to contract around that public policy would be an unwholesome exercise of freedom of contract.” (Internal citations omitted). To determine whether that exception should apply to the Cabela’s and NuVasive agreements, the Court examined the following questions:

      • Would another state’s laws apply in the absence of a choice of law provision?
      • If so, would enforcing the non-compete covenant violate a fundamental public policy of that other state?
      • If so, are the other state’s applicable public policy interests materially greater than the applicable public policy interests of Delaware?

In Cabela’s, the Court found that Nebraska law would apply in the absence of the Delaware choice of law provision, given Nebraska’s stronger contacts with the agreements. Second, the Court concluded that the defendants’ agreements, which were broadly drafted to prohibit ordinary competition, violated Nebraska’s fundamental public policy, which strictly prohibits such agreements unless they are narrowly tailored to prevent misappropriation of customer goodwill, confidential information, or trade secrets. Third, the Court held that Nebraska’s specific public policy against restraints on trade was materially greater than Delaware’s general public policy interest in freedom of contract. As the Court explained, where the contract at issue “is abhorrent and void” under Nebraska public policy, “and where, as here, the formation and enforcement of the contract relate overwhelmingly to [Nebraska], a general interest in freedom of contract is unlikely to be the equal of that public policy[.]” On those grounds, the Court refused to honor the Delaware choice of law provision.

Applying the same criteria, the Delaware Chancery Court reached the opposite conclusion in the NuVasive decision. Just as the facts in Cabelo’s related overwhelmingly to Nebraska, the facts in NuVasive related just as strongly to California. Further, it is generally understood that California law prohibits restrictive covenant agreements broadly. Section 16600 of the California Business and Professional Code strictly prohibits all restraints on competition in the employment context. Further, Section 925 of the California Labor Code prohibits employers from implementing choice of law or choice of forum provisions that circumvent California’s statutory protections or restrict access to a California judicial forum. The Court noted that these provisions reflect strong public policies against the enforcement of non-compete agreements against California residents.

Nevertheless, the NuVasive Court ultimately approved the choice of Delaware law provision due to one important distinguishing factor – the former employee was represented by an attorney in the negotiation of the non-compete agreement. The Court noted that although California Labor Code Section 925 generally prohibits parties from contracting around California substantive laws and California judicial forums, it carves out an exception with respect to employees who are represented by their own legal counsel during the contract negotiations. That carve-out exception, the Court concluded, demonstrated the California Legislature’s recognition “that in the limited subset of cases where the inequality of bargaining strength of the parties to an employment contract is buffered by the employee being represented by independent counsel, and where counsel participated in negotiation of the terms of a choice of law provision, California’s interest in freedom of contract outweighs interest in freedom of employment.” On that basis, the Court held that enforcement of the Delaware choice of law provision would not violate a public policy interest held by California.

The above decisions make clear that Delaware’s public policies may be outweighed by the public policies of a state with a materially greater interest in the litigation. If enforcement of the contract in the manner requested would be abhorrent to the public policies of the latter state, then Delaware courts will not enforce a choice of law provision requiring application of Delaware law. In Cabelo’s and NuVasive, the Court found that Delaware had a lesser interest in the subject matter than Nebraska and California, respectively. However, while the Court also concluded that Nebraska’s interest in the Cabelo’s litigation overrode the parties’ contractually-designated choice of law provision, the same could not be said for California’s interest in the NuVasive litigation, given that the NuVasive defendant negotiated the choice of law provision with the assistance of legal counsel.

Ultimately, the validity of a choice of law provision in a restrictive covenant agreement depends on a number of factors, including the facts at issue as well as the public policies of states that may have a material interest in the subject matter. This analysis should be performed with the assistance of counsel. And, in certain instances, it may be wise for the company to recommend that its prospective employees retain counsel when negotiating their agreements.

Companies needing assistance in the drafting of restrictive covenant agreements are encouraged to contact a Jackson Lewis attorney for related guidance.

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