Delaware has long been favored by businesses for many reasons, including its courts’ deference to parties’ ability to contract. Recently, however, the Delaware Chancery Court was seemingly less deferential to restrictive covenant agreements in circumstances outside of the traditional employment agreement context. In Cantor Fitzgerald, L.P. v. Ainslie, the Court, in a well-reasoned decision which arguably included a survey of this area of law, analyzed restrictive covenants in a partnership agreement that, if breached, resulted in the forfeiture of economic rights by former partners. Cantor Fitzgerald argued that such provisions were conditions precedent to payment and were not subject to a review for reasonableness as a restrictive covenant. The Court disagreed, analyzed the restrictive covenants for reasonableness, and found the provisions unenforceable because the covenants were broader than necessary to protect the partnership or what is commonly referred to as a protectable business interest.

On January 29, 2024, however, the Supreme Court of Delaware, in another well-reasoned and expansive analysis reversed and remanded the Chancery Court’s order. See Cantor Fitzgerald, L.P. v. Ainslie, Case No. 162, 2023, 2024 WL 315193 (Del. Jan. 29, 2024). Similar to the Chancery Court, the Supreme Court weighed the policy interests of the freedom of competition against the freedom of contract embodied in the Delaware Revised Uniform Limited Partnership Act. But, unlike the lower court, the Supreme Court held that the policy interests of contractual flexibility outweighed the state’s interest in protecting competition and determined that the Chancery Court erred by “imposing its notion of reasonableness on the very provisions that, when enforced against other departing partners, redounded to the plaintiffs’ benefit during their tenure as partners.” Id. at *1.

While Cantor Fitzgerald involved a forfeiture-for-competition clause in a partnership agreement, the reasoning underlying the opinion – deference to parties’ freedom to contract – may have broader implications and may be argued that it also applies to shareholder agreements, long-term incentive plans, and similar agreements. Hence, businesses should consider this latest foray into non-compete law when strategizing legitimate ways to protect their business interests.   

We intend to closely follow how courts apply this most recent ruling and businesses are advised to consult with their counsel regarding how this opinion may affect their existing and prospective agreements.

M&A attorneys representing buyers, and their private equity and strategic clients, have long felt comfortable that the courts would uphold restrictive covenants in an acquisition. Even if the restrictive covenant at hand was perhaps somewhat broader than necessary, buyers and their counsel believed that the courts would judiciously apply their “blue pencil” to reform an overbroad covenant to make it enforceable. They also believed that by picking Delaware law and Delaware courts to hear any dispute, their restrictive covenants would be upheld by a court that has a well-deserved reputation for enforcing contracts.

Continue Reading A Delaware Surprise: Busting the Limits of Enforceability of Non-Competes in an M&A Transaction under Delaware Law

Consistent with many jurisdictions which have adopted the Uniform Trade Secrets Act, Delaware’s version expressly preempts common law claims based on the misappropriation of trade secrets. See 6 Del. C. § 2007. In a recent opinion, Vice Chancellor Slights of the Court of Chancery dismissed a claim for unjust enrichment based on defendant’s alleged misappropriation and use of plaintiff’s confidential and proprietary data because Delaware’s trade secret statute “occupies the filed” and preempts claims for common law unjust enrichment. Continue Reading Spam Trap Evading Plaintiff Falls into Statutory Preemption Trap under Delaware Trade Secret Act

shutterstock_6242524By Justin K. Beyer and Matthew I. Hafter

Delaware has long been one of the jurisdictions most friendly to the interests of corporations and is the state of incorporation for a significant majority of corporations. While that trend does not seem likely to change, a new Delaware Chancery Court decision should give pause to choice of law decisions of Delaware corporations with multi-jurisdictional work forces and operations in states other than Delaware.

Recent Ascension Case

In Ascension Ins. Holdings, LLC v. Underwood, C.A. No. 9897-VCG, 2015 Del. Ch. LEXIS 19 (Del Ch. Jan. 28, 2015) (unpublished), the Delaware Court of Chancery recently ruled that, despite a Delaware choice-of-law and venue provision contained in a non-compete agreement, California law applied to the agreement and under California law the agreement was void as a matter of law. In this case, the plaintiff (Ascension) sought an injunction against a former employee (Underwood) for violating a non-compete provision in an employment agreement entered into around the same time Ascension purchased Underwood’s business under an asset purchase agreement.

When Underwood terminated his employment relationship with Ascension, the five-year non-competition period under the asset purchase agreement lapsed. However, the separate non-compete provision of Underwood’s employment agreement provided a two-year tail at the end of the employment, which Ascension argued was specifically contemplated during the negotiations when acquiring Underwood’s business.

Ascension was incorporated in Delaware, but headquartered in California which is also where Underwood worked. In the employment agreement, parties selected Delaware law to govern. Delaware law generally enforces employee non-competition agreements if reasonable in scope and duration and if they advance a legitimate economic interest of the employer. California, in contrast, has a specific statute that renders a covenant not to compete unenforceable against an employee unless made in connection with his or her sale of substantially all of the assets and goodwill of a business non-competition agreements (Cal. Bus. & Prof. Code Sections 16600, 16601).

Choice of Law Analysis

The Chancery Court conducted a choice-of-law analysis to determine whether Delaware or California law would apply. The court found that the parties’ relationship was centered in California, the various contracts were negotiated and entered into there, and the territory in which the defendant employee would be restricted was located there. The court acknowledged that “[u]pholding freedom of contract is a fundamental policy of [Delaware]” but rejected the plaintiff employer’s argument that Delaware’s interest in that policy trumped California’s interest in not burdening its citizens with non-competition covenants. The Delaware court acknowledged that under the applicable California statute the non-compete in the asset purchase agreement would be enforceable to protect the acquired goodwill, but reasoned that the covenant in the employment agreement was directed to a different employer interest; concluding that the restriction in the employment agreement would be prohibited under California law. It held that “allowing parties to circumvent state policy-based contractual prohibitions through the promiscuous use of [choice-of-law] provisions would eliminate the right of the default state to have control over enforceability of contracts concerning its citizens.” On this basis, the Chancery Court denied the employer’s motion for preliminary injunction.

Practical Considerations

For Delaware corporations with employees in many states, this case presents a conundrum:

  • While there is clearly a value to having a single state law govern its relationship with employees in many states, and Delaware law is comparatively employer-friendly with respect to restrictive covenants, there is a risk that the law of each employee’s home state will control unless the corporation has a meaningful connection to Delaware.
  • Similarly, a Delaware corporation headquartered in a state with laws on restrictive covenants that are in the middle of the spectrum (enforceable but narrowly construed or with high proof thresholds) might opt for Delaware law because it is more favorable. But in that situation the employer should evaluate the risk that in reaching for the more friendly laws of Delaware it may lose the benefit of even the modestly friendly provisions of its home state and become subject to laws of each employee’s state which may render non-competition restrictions completely unenforceable or in other respects may be less favorable that those of the employer’s home state.
  • In mergers and acquisitions and similar transactions involving the sale of a business, acquirers commonly require restrictive covenants in both the sale agreement and in separate employment agreements. Acquirers should balance the risk that a court in any particular state may reject the choice-of-law provision that selects Delaware compared with the law of the state in which the acquirer has meaningful contacts.

By Robert Milligan and Grace Chuchla

Using a forum selection clause to transfer a case out of California federal court may have become easier thanks to a recent order from Judge Koh of the United States District Court for the Northern District of California.  In her order, Judge Koh granted defendants’ motion to transfer plaintiff’s complaint to Delaware federal court, finding that the forum selection clauses contained in two agreements were both broadly applicable to tort and statutory claims and enforceable despite allegations that enforcing them would violate California public policy, e.g. the inclusion of an alleged unenforceable jury trial waiver. AJZN, Inc. v. Donald Yu, et al., Case No. 5:12-cv-03348-LHK, (N.D. Cal.)

The agreements and forum selection clauses in question came to be when plaintiff sold all of its assets to one of the defendants in exchange for a warrant giving plaintiff the option to purchase a stake in one of the defendants and that defendant’s assumption of plaintiff’s debt.  This transaction was accomplished via an Asset Purchase Agreement and a Warrant Agreement, both of which contained jury trial waivers and forum selection clauses stating that suits arising under the agreements must be filed in Delaware.    

Following the transaction, the relationship between the parties took a turn for the worse, and on July 3, 2012, the plaintiff filed suit alleging eight causes of action under both federal and California law related to misrepresentations in the Warrant Agreement and in the defendants’ actions, including claims for breach of fiduciary duty and unfair competition.

Defendants responded with a motion to dismiss or transfer based on the forum selection clauses in both the Asset Purchase Agreement and the Warrant Agreement.  In its opposition, plaintiff argued that the claims it brought were not covered by the forum selection clauses and that the clauses were unenforceable due to their inclusion of a jury trial waiver.  Judge Koh disagreed with plaintiff and struck down each of its arguments in turn. The Court found that federal law, not California law, controlled the question of the enforceability of the forum selection clauses and that the plaintiff had the burden of establishing the lawful basis to set aside the clauses.

First and foremost, Judge Koh refuted plaintiff’s assertion of inapplicability by approving of the broad wording of the forum selection clauses.  The text of these clauses reads:

“The parties agree that all actions or proceedings relating to this Agreement (whether to enforce a right or obligation or obtain a remedy or otherwise) will be brought solely in the state or federal courts located in or for Wilmington, Delaware.” (emphasis added)

As Judge Koh saw it, these clauses “do not require that claims seek to enforce the agreements, or seek remedies under the agreements.”  Rather, they “require only that claims relate to, or are based on matter in connection with, the agreements.”  Using this broad interpretation of the forum selection clause, Judge Koh easily held that plaintiff’s claims fall within the scope of the clause.

Plaintiff’s second argument — that the forum selection clauses should be struck down because of their inclusion of a jury trial waiver — met with a similar fate.  Although Judge Koh recognized that jury trial waivers may be unenforceable in California, she did not view the forum selection clause as a contravention of California public policy.  In its briefings, plaintiff did “not presen[t] any reason why a Delaware federal court could not protect [its] interests as well as a California court could.”  Based on this lack of a concrete threat, Judge Koh was not ready to speculate about how a Delaware court would handle this case.  Perhaps it would apply California law.  Perhaps it would apply “some other law that would be equally protective of the interests of California citizens.”  The answer was unclear, and therefore plaintiff did not meet its burden of proving that enforcing the forum selection clauses would contravene California public policy.

Coming on the heels of cases such as Hartstein v. Rembrandt and Hegwer v. American Hearing and Associates — both of which also came from the Northern District and enforced forum selection clauses despite claims of violation of California public policy, i.e. Business and Professions Code section 16600 — AJZN v. Yu is yet another example of how California federal courts are generally willing to enforce forum selection clauses, absent a strong showing that enforcement would be unreasonable or unjust. Notable here is Judge Koh’s insistence that plaintiff  concretely demonstrate that transferring this case to a Delaware court would contravene California public policy.  As Judge Koh stated at the end of her analysis:

“A mere unspecified ‘risk’ that a court could, in theory, enforce the waiver…cannot carry AJZN’s heavy burden to establish that ‘enforcement of the clause would contravene a strong public policy’ of California.” (citing to Argueta v. Banco Mexicano, S.A., 87 F.3d 320, 324 (9th Cir. 1996), emphasis in original).

Although it remains to be seen how concrete of a “risk” California federal judges will demand from plaintiffs in the future,  Judge Koh has provided further authority for courts to demand that plaintiffs all but predict the future if they want to have a forum selection clause declared unenforceable because it contravenes California public policy.  Because we cannot predict the future (try as we might!), only time will tell how this dispute over the enforceability and applicability of forum selection clauses will play out in California. Expect the continued use of aggressive use of forum selection and choice of law provisions to attempt to secure a more favorable forum for future disputes.

Delaware is typically viewed as business friendly as sophisticated parties attempt to avail themselves of Delaware courts through mandatory forum selection, choice of law, and consent to jurisdiction provisions. Delaware also has a  favorable choice of law/venue statute, 6 Del. C. § 2708, which provides that parties to certain contracts over $100,000  may use Delaware choice of law provisions in their contracts and that it “shall conclusively be presumed to be a significant, material and reasonable relationship with this State and [the agreement] shall be enforced whether or not there are other relationships with this State.”

On July 11, 2012, the Delaware Court of Chancery found that former employees are not indispensable parties for purposes of dismissal pursuant to Chancery Court Rule 19 in an action against their new employer for breach of covenants not to compete, misappropriation of trade secrets, and aiding and abetting a breach of fiduciary duty, based on allegations that the new employer improperly persuaded the employees to breach agreements with their former employer.

NuVasive, Inc. v. Lanx, Inc., C.A. No. 7266-VCB (Del. Ch. July 11, 2012) involved claims that Lanx, a medical device company, induced employees of NuVasive, a competitor, to work for Lanx. Specifically, NuVasive alleged that Lanx persuaded employees of NuVasive to breach various restrictive covenants that the employees had with NuVasive and to misappropriate NuVasive’s trade secrets and other proprietary information. NuVasive further alleged that Lanx aided and abetted breaches of fiduciary duty by the former employees. Neither party asserted that the former employees are subject to personal jurisdiction in Delaware or could otherwise be joined. Lanx then moved to dismiss pursuant to Chancery Court Rule 12(b)(7), which allows a defendant to move for dismissal because of a failure to join an indispensable party under Rule 19.

Under Chancery Court Rule 19(a), the Court must determine whether an absent person is a necessary party to the litigation. If an absent party is deemed necessary and cannot be joined, the Court must then, pursuant to Rule 19(b), “determine whether in equity and good conscience the action should proceed among the parties before it, or should be dismissed, the absent person being thus regarded as indispensable.” Rule 19(b) lists four factors for the court to consider in determining if a necessary party is indispensable to the action, including the extent to which a judgment rendered in the person’s absence would be prejudicial to those already parties, and whether the plaintiff will have an adequate remedy if the action is dismissed for nonjoinder.

In NuVasive, the Court found that, while the former employees of NuVasive were necessary parties to the litigation concerning the restrictive covenant-based claims, they were not indispensable parties because the court could protect the rights of the absent parties by declining to enter injunctive relief, or by crafting a limited injunction that did not inappropriately prejudice the absent employees. 

As to the remaining allegations, the Court found that the former NuVasive employees were not necessary parties for claims based on trade secret misappropriation and aiding and abetting a breach of fiduciary duty. Specifically, the Court concluded that any ruling on the issues raised by this litigation would only affect the former employees’ employment prospects with the new employer to the extent that their employment actually did rely on the misappropriation of trade secrets. Thus, the Court found that they were not necessary parties for the trade secret misappropriation claim. Nor were they necessary parties as to the aiding and abetting breach of fiduciary duty claims, because any potential reputational harm that could be suffered by the former employees in this litigation, in their absence, would not be sufficient to render them necessary parties.

           Delaware Court of Chancery Vice Chancellor J. Travis Laster, faced with an unreasonable non-compete/non-solicitation agreement, indicated that he would have preferred to hold it invalid but said that he had no choice other than to modify its terms because its Maryland choice-of-law provision requires judicial “blue penciling.” He did enjoin the ex-employee from using his ex-employer’s customer list, a trade secret, but held that the ex-employee may call on any customer whose name is within his own knowledge.

            Delaware Elevator, Inc. (“DEI”), a national elevator installer and servicer, sued ex-employee John Williams who had 20 years of experience in the industry (six of them with DEI) at the time he left that corporation and started his own — one man — competing elevator maintenance company. He had signed an agreement with DEI (a) barring him for three years after leaving its employ from working in a competing business within 100 miles of any DEI office, and (b) prohibiting him from soliciting business from anyone who during the last six months of his employ had been either an actual DEI customer or a potential customer DEI was actively soliciting. While he claimed his signature on the agreement was a forgery, the court said that no rational fact finder could accept his claim. 

            The agreement contained a Maryland choice-of-law provision and a stipulation that a violation would inflict irreparable harm on DEI. Maryland law upholds non-competes if the restraints are reasonably necessary for the protection of the employer, do not impose an undue hardship on the employee, and are in the public interest. Even DEI recognized the unreasonableness of the territorial restriction as written (within 100 miles of any DEI office) and sought to enforce the agreement within 100 miles of just the Newark, Delaware office where Williams worked.   

            The Vice Chancellor observed that Williams has 34 years in the workforce, has personal and family ties to the area where he has been working, and could not readily re-locate or find an equivalent job in a new field. Rhetorically, the court asked DEI’s attorneys “how they would fare if forced to re-start in a far-off jurisdiction, to re-invent themselves as practitioners in a completely different subject-matter area, or to leave the law entirely and find employment in another industry.” 

            While he might have preferred to invalidate the agreement altogether, the Vice Chancellor stated that Maryland “does not authorize a policy-based refusal to enforce an unreasonable non-compete agreement. Maryland law instead calls on the court to carve back overly broad restrictive covenants by wielding the judicial ‘blue pencil.’” Accordingly, he modified the restrictive provisions to a two-year-30-miles-from-Newark-radius (since the two year period began January 17, 2010, Williams’ date of termination, it will expire less than one year after the decision was announced in March 2011). The court observed that, as modified, Williams would be able to earn a living by using his contacts and knowledge of the industry outside the non-compete zone immediately, and within the zone shortly, while at the same time DEI’s relationships with existing and prospective customers were adequately protected. 

            Williams admitted that he took a DEI customer list with him and used it. Because the list was held to constitute a trade secret, he was ordered to destroy all electronic and paper copies. However, the court said he is free to call on customers he knows, even if their names are on the list. A hearing on damages for wrongful use of the list will be scheduled.

            Employers should be cognizant of the applicable legal principles when they include a choice-of-law provision in a non-compete or non-solicitation agreement. If DEI’s agreement with Williams had provided for application of Delaware law, the agreement might have been voided altogether. By applying Maryland law, the employer salvaged at least some protection. Designation of another state’s law might have been even more favorable to the employer. Ask your Seyfarth Shaw trade secrets attorney for advice about choice-of-law provisions.

In the inaugural session of the 2024 Trade Secrets Webinar Series, our panelists meticulously examine pivotal legislation, landmark cases, and legal advancements spanning trade secrets and data theft, non-competes and restrictive covenants, and computer fraud on a national scale. Tailored specifically for general counsel, labor and employment counsel, IP counsel, and HR professionals, this webinar offers essential insights into trade secrets, non-competes and restrictive covenants, and computer fraud.

Here are the key takeaways from the webinar:

  1. Federal agencies continue to crack down on the use of non-compete covenants. The FTC moved forward with its proposed ban of non-competes with employees and we expect to see a formal rule released in mid-spring 2024. Legal challenges are expected. The NLRB’s General Counsel also released a memorandum signaling enforcement actions against companies using non-competes with their non-exempt workforce and we have seen at least one agency action thus far. We also saw proposed federal legislation banning or narrowing the use of non-competes, which we expect to be reintroduced in 2024. Lastly, we saw federal agencies insisting on broad whistleblower protections in confidentiality agreements with impacted employees and customers.
  2. State legislatures continued to narrow the use of the non-competes with employees. Minnesota adopted a ban on non-competes. California adopted two new law that further limit the use of restrictive covenants in California and require employers to provide notice to current and former employees (since January 1, 2022) by February 14, 2024 that any operative non-competes that they signed are void. California’s new law positions the state as a beacon on the hill for employees and California employers attempting to shed employee non-compete covenants that may be enforceable in other jurisdictions.
  3. We saw an increasing hostility towards restrictive covenants by certain judicial officers in the Delaware Chancery Court, including in cases involving employment and equity agreements with out-of-state executives, with a notable differing view in recent Delaware Supreme Court case, which reaffirmed Delaware’s deference to parties’ freedom to contract.
  4. We continued to see large trade secret verdicts and an increasing focus on novel trade secret damages theories. We saw notable decisions addressing the recovery of damages for non-U.S. sales under the Defend Trade Secrets Act and the recovery of unjust enrichment damages when damages for actual losses are not sufficient.

To view the webinar recording, click here.

Tuesday, January 30, 2024
1:00 p.m. to 2:00 p.m. Eastern
12:00 p.m. to 1:00 p.m. Central
11:00 a.m. to 12:00 p.m. Mountain
10:00 a.m. to 11:00 a.m. Pacific

REGISTER HERE

About the Program

Join Seyfarth’s partners, Michael Wexler, Robert Milligan, and Kate Perrelli for an insightful analysis of the key legal developments in 2023. Gain valuable perspectives that will equip you to navigate the challenges and capitalize on opportunities in this significant area.

In the inaugural session of the 2024 Trade Secrets Webinar Series, our panelists will meticulously examine pivotal legislation, landmark cases, and legal advancements spanning trade secrets and data theft, non-competes and restrictive covenants, and computer fraud on a national scale. Tailored specifically for general counsel, labor and employment counsel, IP counsel, and HR professionals, this webinar offers essential insights into trade secrets, non-competes and restrictive covenants, and computer fraud.

This program will delve into the following key topics:

  • New Legislation Impact and Key Judicial Decisions: Gain practical insights into the impact of new legislation influencing the enforcement of non-competes and restrictive covenants in several jurisdictions, including material changes in California, Minnesota, and potentially New York, and significant judicial decisions impacting enforcement, including in Georgia and Delaware. 
  • Federal Landscape: Stay abreast of legislative and regulatory activity and updates, including the FTC’s proposed rule addressing non-competes with workers, which may significantly impact the enforcement of non-competes nationwide in 2024, and continued NLRB pronouncements. 
  • Trade Secret Misappropriation: Explore significant recent decisions, covering critical aspects such as damages, fees, misappropriation, and pleading standards, including state and Defend Trade Secrets Act decisions. 
  • Computer Fraud Landscape: Understand the current state of computer fraud claims post-recent Supreme Court rulings including significant state computer fraud decisions.

Practical Solutions:

  • Agreements and Policies: Implement best practices for updating and fortifying agreements and policies to protect company assets and trade secrets.
  • Multistate and Remote Work Challenges: Address the unique challenges faced by multistate employers and those managing remote or hybrid workforces.

Exclusive Resource:

  • 50-State Non-Compete/ Trade Secret Desktop Reference: Access our comprehensive overview for an in-depth understanding of non-compete secret laws across the United States. To access, click here.

Speakers

Michael Wexler, Partner, Seyfarth Shaw LLP

Robert Milligan, Partner, Seyfarth Shaw LLP

Kate Perrelli, Partner, Seyfarth Shaw LLP


If you have any questions, please contact Sadie Jay at sjay@seyfarth.com and reference this event.

This program is accredited for CLE in CA, IL, and NY. Credit will be applied as requested but cannot be guaranteed for TX, NJ, GA, NC and WA. The following jurisdictions may accept reciprocal credit with our accredited states, and individuals can use the certificate they receive to gain CLE credit therein: AZ, AR, CT, HI and ME. The following jurisdictions do not require CLE, but attendees will receive general certificates of attendance: DC, MA, MD, MI, SD. For all other jurisdictions, a general certificate of attendance and the necessary materials will be issued that can be used for self-application. Please note that attendance must be submitted within 10 business days of the program taking place. CLE decisions are made by each local board and can take up to 12 weeks to process. If you have questions about jurisdictions, please email CLE@seyfarth.com.

Please note that programming under 50 minutes of CLE content is not eligible for credit in NJ, and programming under 60 minutes of CLE content is not eligible for credit in GA. Programs that are not open to the public are not eligible for credit in NC.

In 2023, Seyfarth’s Trade Secrets, Computer Fraud & Non-Compete practice group presented a series of dynamic and insightful CLE webinars, addressing pivotal challenges confronting businesses head-on. The breadth of our discussions encompassed a spectrum of critical topics:

  1. FTC Proposes Rule Banning Use of Non-Competes. Now What?
  2. 2022 Trade Secrets & Non-Competes Year in Review
  3. Commercial Litigation Outlook: Insights and Predictions for Litigation Trends in 2023
  4. NLRB and Restrictive Covenants: Trends in Employment Confidentiality
  5. Managing Trade Secrets in a Remote Work Environment
  6. What Employers Need to Know Regarding Non-Compete Changes in 2023

To conclude our impactful 2023 webinar series, we’ve carefully compiled key takeaways from each session. If you missed any sessions, recordings are available on our blog or through the provided links. We’re excited to share that Continuing Legal Education (CLE) credit is attainable by watching the webinar recordings. For CLE credit inquiries, please email cle@seyfarth.com after viewing the webinar.

Continue Reading 2023 Trade Secrets Webinar Series Recap: Key Takeaways and Access to Recordings