By Robert Milligan and Grace Chuchla
There are not many issues that the United States Supreme Court can unanimously resolve in five short pages.
The preeminence of the Federal Arbitration Act (“FAA”) is apparently one such issue, as the Supreme Court recently illustrated in its November 26 per curium opinion in Nitro-Lift Technologies LLC v. Howard, 568 U.S. __ (November 26, 2012).
In the decision, the Supreme Court reaffirmed the FAA’s national policy in favor of arbitration and emphatically shot down an attempt by the Oklahoma Supreme Court to exert judicial review over the enforceability of a non-compete agreement that contained a mandatory arbitration provision.
This dispute arose when Eddie Lee Howard and Shane D. Schneider left Nitro-Lift Technologies (“Nitro-Lift”) and began working for one of Nitro-Lift’s direct competitors in Arkansas. Upon learning of Howard and Schneider’s new employment, Nitro-Lift served them with a demand for arbitration in an effort to enforce the non-competition agreements that both had signed at the outset of their employment. These agreements contained a clause that required arbitration in Houston, Texas of all disputes arising under the agreement and for the application of Louisiana law. However, despite this arbitration clause, Howard and Schneider responded to Nitro-Lift’s demand for arbitration by filing suit in the District Court of Johnson County, Oklahoma and asking the court to enjoin the enforcement of their non-competition agreements as contrary to Oklahoma state law.
The district court dismissed Howard and Schneider’s complaint because the arbitration clause demanded that an arbitrator, rather than the court, settle such disputes. However, plaintiffs appealed to the Oklahoma Supreme Court, which not only accepted the appeal but also ordered the parties to demonstrate why Okla. Stat., Tit. 15, §219A should not be the deciding factor in this dispute over the enforceability of a non-competition agreement. The Oklahoma Supreme Court held that: 1) in conformance with its prior jurisprudence, the existence of an arbitration agreement in an employment contract does not prohibit judicial review of the underlying agreement; 2) as drafted, the non-competition covenants are void and unenforceable as against Oklahoma’s public policy expressed by the Legislature’s enactment of Okla. Stat., Tit. 15, §219A; and 3) judicial modification of the covenant not to compete is inappropriate where, as here, the contractual provisions would have to be substantially excised, leaving only a shell of the original agreement, and would require the addition of at least one material term. For an in-depth look at what the Oklahoma Supreme Court said in its November 2011 opinion, see our previous post.
In a nutshell, the US Supreme Court was not pleased with the Oklahoma Supreme Court’s attempt to circumvent and weaken the FAA and the disregard that it showed toward Supreme Court precedent. Despite the Oklahoma court’s claim that it had conducted an “exhaustive review of US Supreme Court decisions construing the Federal Arbitration Act,” the Supreme Court flatly rejected the argument that its previous decisions did “not…inhibit [Oklahoma’s] review of the underlying contract’s validity” (slip op. at 3).
Under its controlling authority, the US Supreme Court ruled that an arbitrator must decide whether the non-compete agreement was valid. The Court stated that “it is a mainstay of the [FAA’s] substantive law that attacks on the validity of the contract, as distinct from attacks on the validity of the arbitration clause itself, are to be resolved by the arbitrator in the first instance, not by a federal court.”
Additionally, the Court took issue with the Oklahoma Supreme Court’s claim that its “decision rests on adequate and independent state grounds” (slip op. at 3). Rather, as the Supreme Court saw it, Oklahoma’s reasoning “necessarily depended upon a rejection of the federal claim” and controlling federal laws and precedents (slip op. at 3). Thanks to the all-important Supremacy Clause of the US Constitution, such a rejection cannot stand. Thus, per the Supreme Court’s previous decisions in cases such as Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440 (2006), Preston v. Ferrer, 522 U.S. 346 (2008), and Prima Paint Corp. v. Flood & Conklin Mfg, Co., 388 U.S. 395 (1967), the question of whether or not Howard and Schneider’s non-competition agreements are enforceable under §219A is not a proper question for a state court to answer. In short, although the validity of an arbitration agreement is subject to a court’s review, “the validity of the remainder of the contract (if the arbitration provision is valid) is for the arbitrator to decide” (slip op. at 4).
Coming on the heels of AT&T Mobility v. Concepcion, 563 US __ (2011), this opinion is yet another clear affirmation of the US Supreme Court’s desire to bolster the power of the FAA. Especially notable in this case is the fact that the non-competition agreement in question was, as we discussed in our previous post, unenforceable under Oklahoma state law. Nevertheless, the Supreme Court still chose to remove the question of the agreement’s enforceability from the hands of the state court and turn it over to an arbitrator – a clear demonstration of the high court’s desire to maintain the process of arbitration even in the face of a legal question with an all but perhaps foregone conclusion at least under Oklahoma law. Query though whether an arbitrator in Texas, where the arbitration is to be conducted pursuant to the agreement, may have a different view of the enforceability of the non-competition provisions and may question the application of Oklahoma law where the agreement specifies the application of Louisiana law. Finally, employers and employees alike should note that there is nothing in this opinion that alters the status of non-competition agreements under Okla. Stat., Tit. 15, §219A. Such agreements still remain generally unenforceable, although such a question will now often be for an arbitrator to decide if an employer’s utilizes arbitration agreements.
As far as takeways from this decision, employers should carefully consider whether disputes with employees concerning non-compete/trade secrets issues should be resolved through the courts or arbitration and draft their agreements accordingly. Some legal commentators such as John Marsh believe that the arbitration of non-compete/trade secret disputes in the employment context should rarely be handled by arbitration and that employers should include carve outs for such disputes if they generally employ arbitration agreements with their employees. Please also see Ken Vanko’s informative summary of the case. In our experience some of the reasons why the courts may be preferably for such disputes include the ability to obtain injunctive relief more expeditiously as well as the appearance of authority and finality of a court order, rather than an arbitrator’s order. A word of caution on the use of such exclusions, however, as at least in California, some courts have pointed to such exclusions in arbitration agreements as purported evidence of unconscionability to invalidate such agreements. Notwithstanding those decisions, a California federal court recently ruled that the use of such an exclusion was not unconscionable.
Accordingly, the utilization of arbitration agreements, coupled with forum selection, choice of law, and consent to jurisdiction provisions, specifying an employer’s pro non-compete forum, with employees from jurisdictions that limit or prohibit non-compete agreements may provide some employers with additional options that they did not otherwise consider, notwithstanding the drawbacks discussed above. Such a strategy is not without risk, however, as employees can always attempt to challenge such provisions in their home forum on several grounds, including unconscionability, adhesion, or lack of reasonableness under forum selection standards, but the scope of such challenge may be limited by this decision, the United States Supreme Court’s other recent pro arbitration decisions, as well as future Supreme Court decisions.