Delaware court ruling limits employers' ability to enforce noncompete agreements

Et tu, Delaware?

 By: Kevin Burke

The enforceability of noncompete agreements in the United States has taken another hit this quarter, this time from the typically employer-friendly Delaware Chancery Court.

If your business is a Delaware corporation headquartered or with employees in a state other than Delaware, a recent decision out of the Chancery Court involving noncompete agreements will likely affect your company.[1]

In Ascension Insurance Holdings, LLC v. Underwood,[2] the Chancery Court of Delaware refused to enforce a noncompete agreement, expressly disregarding the parties’ agreement to apply Delaware law on public policy grounds in the process.

Although the parties initially agreed that Delaware law would govern the agreement, the court applied California law in rejecting the plaintiff employer’s request for an injunction against its former employee. This decision may come as an unwelcome surprise to many Delaware corporation employers who have come to rely on Delaware law as being both predictable and employer-friendly.

Delaware is strongly contractarian in its law. The Chancery Court routinely respects the rights of parties to freely contract and to be able to rely on the enforceability of their agreements. When parties choose to apply Delaware law in their agreements, Delaware law will be applied with only very limited exceptions. In fact, the Underwood court expressly noted that “[u]pholding freedom of contract is a fundamental policy of [Delaware].”[3]

However, where it is clear that the public policy of the so-called “default state” – the state where the contract was formed and will be enforced – conflicts drastically with Delaware law on a particular issue, Delaware law will not be applied.

Put another way, Delaware is generally supportive of choice-of-law provisions, but recognizes that allowing parties to circumvent state policy-based contractual prohibitions through the promiscuous use of such provisions would eliminate the right of the default state to have control over enforceability of contracts concerning its citizens.

Unlike Delaware, which allows employers to restrict former employees from competing so long as such restrictions are reasonable in scope and necessary to protect the former employer’s legitimate business interests, California public policy disallows contractual agreements not to compete.[4]

In Underwood, the Chancery Court analyzed the relationship between the employer and its former employee and found that the dealings between them all centered in California. Since the noncompete agreement at issue was “abhorrent and void”[5] under California policy, the Delaware Court refused to apply Delaware law and would not enforce the restrictive covenant.

What does this instruct Delaware corporations headquartred in states other than Delaware?

In drafting restrictive covenants containing noncompete provision, a shrewd Delaware corporation will no longer merely rely on a choice-of-law provision citing Delaware to guaranty the application of Delaware’s relatively pro-employer noncompete laws.

Rather, a prudent Delaware corporation must take into account the extent of the nexus between the agreement it seeks to enforce and the state in which the company seek to enforce it. If your Delaware corporation and its employees are headquartered in a state with a public policy (or outright ban) against noncompete agreements, best practices dictate the implementation of a plan to protect against competition from former employees without relying on the application of Delaware law alone.

A narrowly tailored non-solicitation agreement or a written policy against the misuse of proprietary information are two examples of ways to protect against future unfair competition from former employees.

As always, it is critical to consult with counsel experienced in this area of the law and with knowledge of the specific needs of your business.

[1] http://courts.delaware.gov/opinions/download.aspx?ID=218380

[2] Chancery Court of Delaware, January 27, 2015, C.A. No. 9897-VCG

[3] Ascension Ins. Holdings, LLC v. Underwood, 2015 Del. Ch. LEXIS 19, *13

[4] Cal. Bus. & Prof Code §16601

[5] Underwood, 2015 Del. Ch. LEXIS 19, *4