Citing Nebraska’s fundamental public policy, the U.S. Court of Appeals for the Third Circuit recently affirmed a District Court’s refusal to enforce a Delaware choice of law clause in a non-compete agreement signed by a Nebraska employee.

Delaware law is generally favorable to enforcing non-compete restrictions.  Hundreds of thousands of new corporate entities (corporations, LLCs, LPs, LLCs, etc.) are created in Delaware every year, and the First State is home to more than two-thirds of the Fortune 500 and 80 percent of all firms that go public.[1] Many of these Delaware entities are headquartered in, and have operations in, states with less favorable non-compete law than Delaware.  Choosing Delaware law to govern non-compete restrictions thus seems like a bullet-proof strategy for side-stepping unfavorable state law and enforcing non-compete restrictions.  However, a Delaware choice of law clause does not guarantee enforcement.

As we recently reported, incorporation (or formation) in Delaware is a legally sufficient basis for choosing Delaware law to govern non-compete restrictions – even if the employer is headquartered in another state and the employee works in another state.[2] Stated differently, and in terms of the Restatement (Second) of Conflicts of Laws (“Restatement”), incorporation or formation in Delaware by itself creates a “substantial relationship” with Delaware.  Restatement § 187(2)(a).

But that does not end the choice of law inquiry.  A Delaware choice of law clause will not be enforced if application of Delaware law is “[1] contrary to a fundamental public policy of a state which [2] has a materially greater interest than the chosen state in determination of the particular issue and which [3] would be applicable law in the absence of an effective choice of law by the parties.”  Restatement § 187(2)(b).  In the situation we’re discussing – i.e., the only connection to Delaware is the employer’s incorporation or formation there – the state where the employee works will have a materially greater interest in the dispute than Delaware, and would be the applicable law in the absence of the choice of law clause.  Validity of the Delaware choice of law clause thus rises or falls on whether Delaware law is contrary to a public policy of the state in which the employee works.

In Cabela’s LLC v. Highby, 362 F. Supp. 3d 208 (D. Del. 2019), the court had to decide the validity of a Delaware choice of law provision where the employee lived and worked in Nebraska.  Nebraska non-compete law is more restrictive than Delaware law.  The court explained that Nebraska non-competes may “restrain competition by improper and unfair methods, but may not constrain ordinary competition,” while in Delaware “[a]n agreement prohibiting ordinary competition is enforced so long as it is not oppressive to an employee.”  Id. at 217-18 (citations omitted).  The court found that the non-compete at issue restrained ordinary competition, and was therefore unenforceable under Nebraska law, but would be enforceable under Delaware law.  The court therefore held that “the application of Delaware law would be contrary to a fundamental policy of Nebraska,” and refused to enforce the Delaware choice of law clause.  Id. at 219.

The mere fact that an agreement is enforceable in one state but not another is not necessarily dispositive of the contrary-to-a-fundamental-policy issue.  However, the Third Circuit recently affirmed the district court’s decision.  In doing so the Third Circuit specifically refused the employer’s request to certify the question to the Delaware Supreme Court, noting that “we do not find the law to be unsettled on this point.”  Cabela’s LLC v. Highby, 2020 WL 1867922, at *1 n.8 (3d Cir. April 14, 2020).[3]

Practitioners, particularly those who advise their corporate colleagues on mergers and acquisitions, often review employment agreements that contain Delaware choice of law provisions.  These practitioners are entirely correct in telling their corporate colleagues and clients that Delaware non-compete law is generally favorable to the employer.  However, the careful practitioner will also add that enforceability may ultimately depend on where the employee works.


[1] https://corp.delaware.gov/stats/

[2] https://www.tradesecretsandemployeemobility.com/2020/04/articles/non-compete-agreements/first-circuit-massachusetts-employee-must-abide-by-a-restrictive-covenant-governed-by-a-delaware-choice-of-law-clause-the-more-things-change-the-more-they-stay-the-same-part-ii/

[3] https://www2.ca3.uscourts.gov/opinarch/191423np.pdf

Joining many other states that in recent years have enacted laws regarding physician non-competition agreements, Indiana recently enacted a statute that will place restrictions on such agreements which are originally entered into on or after July 1, 2020.

Under Pub. L. No. 93-2020 (to be codified in part as Ind. Code § 25-22.5-5.5) (2020), which will take effect on July 1, 2020, for a non-compete to be enforceable against a physician licensed in Indiana, the agreement must contain the following provisions:

  1. A provision that requires the employer of the physician to provide the physician with a copy of any notice that (A) concerns the physician’s departure from the employer, and (B) was sent to any patient seen or treated by the physician during the two year period preceding the end of the physician’s employment or contract.
  2. A provision that requires the physician’s employer to, in good faith, provide the physician’s last known or current contact and location information to a patient who (A) requests such information and (B) was sent to any patient seen or treated by the physician during the two year period preceding the end of the physician’s employment or contract.
  3. A provision that provides the physician with (A) access to or (B) copies of any medical record associated with a patient described above upon receipt of the patient’s consent.
  4. A provision that provides the physician with the option to purchase a complete and final release from the terms of the non-compete at a reasonable price.
  5. A provision that prohibits the providing of patient medical records to a requesting physician in a format that materially differs from the format used to create or store the medical record during the routine or ordinary course of business, unless mutually agreed otherwise.

As is clear from these requirements, preserving a patient’s right to choose a physician, including by continuing to be seen or treated by a physician departing from a particular practice, was an important factor considered by Indiana legislators.  Also, given that Indiana law rarely allows for judicial modification of restrictive covenants, this new statute will be onerous for practices/employers who do not pay close attention to drafting their non-compete agreements.

A recent decision issued by the U.S. District Court for the Northern District of California, San Jose Division, presents a stark example of what can result when a defendant accused of trade secret misappropriation is careless in preserving electronically stored information (“ESI”) relevant to the lawsuit.

Silicon Valley-based autonomous car startup WeRide Corp. and WeRide Inc. (collectively, “WeRide”) sued rival self-driving car company AllRide.AI Inc. (“AllRide”), along with two of its former executives and AllRide’s related companies, asserting claims for misappropriation under the federal Defendant Trade Secrets Act and the California Uniform Trade Secrets Code, along with numerous other claims.  WeRide secured a preliminary injunction from the Court, directing AllRide not to use or disclose WeRide’s confidential information and trade secrets, and specifically directing defendants not to destroy evidence.

Discovery showed that the defendants did not heed the Court’s injunction, instead engaging in what the Court called a “staggering” amount of spoliation, much of which AllRide conceded.  The spoliation included:

  • Failure to disable a 90-day automatic deletion of emails in AllRide’s computer system;
  • Destruction of email accounts assigned to or used by the individual defendants;
  • Destruction of the source code alleged to have been stolen; and
  • Wiping clean one laptop and deleting files from another laptop.

Evaluating defendants’ actions under Federal Rules of Civil Procedure 37(b) and 37(e), the Court issued terminating sanctions against AllRide and the individual defendants, striking their answers and entering defaults against them, and holding that they must pay WeRide’s attorneys’ fees relating to discovery and motion practice regarding the spoliation.

Although an extreme example, this decision serves as a reminder of the importance of preserving ESI, even when litigation is a possibility.

When Massachusetts enacted the Massachusetts Noncompetition Agreement Act (“MNCA”) in mid-2018, some commentators suggested that the statute reflected an anti-employer tilt in public policy. But, we advised  that sophisticated employers advised by knowledgeable counsel could navigate the restrictions set forth in the MNCA.  As reported here, the May 2019 decision from the District of Massachusetts in Nuvasive Inc. v. Day and Richard, 19-cv-10800 (D. Mass. May 29, 2019) (Nuvasive I) supported our initial reading of the MNCA.   The First Circuit’s April 8, 2020 decision in Nuvasive, Inc. v. Day, No. 19-1611 (1st Cir. April 8, 2020) (Nuvasive II), which upheld the District Court’s decision, provides further evidence that Massachusetts courts will still enforce contractual choice of law provisions when considering requests to enforce certain restrictive covenants in employment contracts.  Indeed, in Nuvasive II, the First Circuit concluded that the MNCA, by its terms, does not apply to non-solicitation agreements, and that the Massachusetts employee, Day, had not demonstrated a legal basis for the District Court to ignore the Delaware choice of law clause in his employment agreement.

Nuvasive II, like Nuvasive I, presented the question of whether an employer incorporated in Delaware could enforce a non-solicitation agreement, which was governed by Delaware law, against a former employee, who was a Massachusetts resident.  Massachusetts law, like the law of most states, generally requires courts to enforce a contractual choice of law provisions.  Nonetheless, in Nuvasive II, the former employee argued that the District Court erred in enforcing a Delaware choice of law clause because: (1) Delaware had no “substantial relationship” to the parties or the transaction; and (2) Delaware law was contrary to the fundamental policy of Massachusetts.  The First Circuit, like the District Court, rejected both arguments.

The First Circuit summarily rejected the employee’s argument that the choice of law clause was unenforceable because Delaware lacked the requisite relationship to the contract and the parties.  The Court noted that the employer was incorporated in Delaware and held that this was a sufficient basis on which to apply Delaware law to the restrictive covenant.  Indeed, the First Circuit emphasized that the Restatement of Contracts generally recognizes the validity of choice of law clauses that require application of the law of the state where one of the parties resides or maintains its principal place of business.   Thus, Nuvasive II recognizes the employer’s right to include a choice of law clause that requires application of the law of the state where it is incorporated or maintains its principal place of business.

Similarly, the First Circuit did not linger too long over the employee’s argument that the application of Delaware law would be contrary to the fundamental public policy of Massachusetts.   Citing the Massachusetts Supreme Court’s 2020 opinion in Automile Holdings, LLC v. McGovern, 136 N.E. 1207, 1271 n. 15, (Mass. 2020), the Court quickly concluded the MNCA was not applicable to the dispute at all, because it does not apply to agreements executed before October 1, 2018 and because it “does not apply to non-solicitation agreements.”   Further, the Court concluded that Massachusetts’ material change doctrine, which requires new restrictive covenants to be executed with each material change in an employment relationship, did not bar the application of Delaware law to the parties’ dispute.  In reaching this conclusion, the First Circuit defined the types of events that qualified as “material changes” as employer-initiated changes to the employment relationship, such as pay cuts, demotions, and material breaches of an employment contract by the employer.   Notably, the First Circuit rejected the contention that “an employee’s own choice to terminate” his employment by accepting a different position with his employer could be “a ‘qualifying’ change under Massachusetts’ ‘material change’ doctrine.”   Thus, as we initially predicted, the enactment of the MNCA does not bar out of state employers from enforcing reasonable restrictive covenants against Massachusetts employees.

The First Circuit expressly declined to consider whether either the MNCA or the material change doctrine embodied a “fundamental policy” of Massachusetts, because it found that the application of Delaware law did not violate either the MNCA or the material change doctrine.  Thus, out-of-state employers can expect Massachusetts employees seeking to avoid restrictive covenants governed by the laws of other states to continue to argue that the MNCA or the material change doctrine reflect fundamental policies of Massachusetts, which invalidate choice of law clauses.   Accordingly, out-of-state employers with Massachusetts employees should review the guidance in Nuvasive I and Nuvasive II and consult counsel when drafting restrictive covenants in employment contracts with Massachusetts employees.

For any attorney about to rush into New York State court to seek an injunction or temporary relief with regard to a violation of a non-compete or other restrictive covenant, or with regard to misappropriation of trade secrets, think again about venue.

By Administrative Order, dated March 22, 2020, Chief Administrative Judge Lawrence Marks has decreed that until further notice, New York State courts are accepting no filings unless the filings concern an emergency matter (as defined in the Order’s Exhibit A).  Neither restrictive covenant nor trade secret matters count as “emergencies.”

This Order thus effectively bars the initiation of non-compete or trade secret matters for its duration (and any filings in such actions that are pending) in New York state court.  If called upon to initiate action in New York on such a matter (including seeking temporary/injunctive relief), counsel must look to federal court in New York, or other potential state (or federal) venues.  If diversity jurisdiction does not exist, consider a claim under the Defend Trade Secrets Act or other federal statute to secure federal question jurisdiction.

The Administrative Order was issued in conjunction with the Executive Order issued by Governor Andrew Cuomo on March 20, 2020, which tolls deadlines until April 19, 2020.

On January 9, 2020, the Federal Trade Commission (“FTC”) held a public workshop in Washington, DC to examine whether there is a sufficient legal basis and empirical economic support to promulgate a Commission rule that would restrict the use of non-compete clauses in employment contracts.  At the conclusion of the workshop, the FTC solicited public comments from interested parties on various issues, including business justifications for non-competes, effect of non-competes on labor-market participants and efficacy of state law for addressing harms arising from non-competes.

On March 12, 2020, attorneys general from seventeen states (including California, Illinois, New York and Washington), Puerto Rico and the District of Columbia (the “AGs”) submitted extensive comments to the FTC.  The AGs take the position that non-competes harm workers by suppressing wages and degrading non-wage benefits, and harm consumers by reducing business’ access to skilled and unskilled labor and by reducing innovation. The AGs find the usual justifications for non-competes (to protect trade secrets and investments in training workers) unpersuasive, and note that non-competes–particularly for low wage workers–usually are not freely bargained for.

Declaring their support for “federal rulemaking that is consistent with our ability to pursue enforcement and legislative priorities to the benefit of workers and consumers,” the AGs also ask that the FTC work with AGs to tackle abusive use of non-competes through enforcement actions, further study, issuance of guidelines, and educational initiatives.

In the coming weeks, the FTC will be evaluating the AGs’ comments, as well as comments from many other groups and individuals, as it decides what further actions, if any, it will take with regard to non-competes.  Stay tuned.

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The Illinois legislature is once again setting its sights on covenants not to compete.  In 2016, Illinois enacted the “Illinois Freedom to Work Act,” prohibiting employers from entering into covenants not to compete with “low wage” employees.  In February 2020, Illinois legislators filed four bills targeting covenants not to compete for all Illinois employees.

SB 3021 and HB 4699 are identical in substance, and the most drastic.  These bills seek to prohibit all covenants not to compete in Illinois:  “… no employer shall enter into a covenant not to compete with any employee of the employer.”  [Emphasis added].  These bills define “employee” as “any individual permitted to work by an employer” – not just Illinois-based employees – raising extraterritoriality issues off the bat.  An identical bill prohibiting covenants not to compete for all Illinois employees was defeated in the Illinois House of Representatives in 2019, 62 to 37, with 3 “Present” votes.

HB 5454 purports to require an employer “that elects to enforce a covenant not to compete” to pay “full compensation, including all benefits” to employees during either “(1) the time specified in the covenant not to compete or (2) until the separated employee is employed full-time at a commensurate rate of pay and benefits in a field of work not subject to the covenant not to compete.”  However, this bill would simply add a new section to the Illinois Freedom to Work Act, which defines a “covenant not to compete” as “an agreement between an employer and a low-wage employee,” and declares any such agreement illegal and void.  HB 5454 thus seems fundamentally flawed on its face, because it is limited to covenants not to compete with low-wage employees, which are already illegal and void.  Setting that fixable point aside, this bill follows the lead of Massachusetts’ non-competition agreement statute in requiring garden leave-type compensation during the restricted period.

HB 3430 is the most comprehensive of the February 2020 bills.  This bill:

  • Defines “covenant not to compete” to include agreements that “impose adverse financial consequences on a former employee” for competitive activities;
  • Defines “employee” in accordance with the Illinois Wage Payment and Collection Act, which excludes independent contractors;
  • Codifies the common law requirements that an employee receive adequate consideration, and that the covenant be ancillary to a valid employment relationship;
  • Defines “consideration” as either two years of employment, or “some other fair and reasonable consideration specifically bargained for in exchange for the covenant not to compete” (a clear nod to Fifield v. Premier Dealer Services, 2013 IL App (1st) 12037, 993 N.E.2d 938);
  • Codifies the common law requirements set forth in Reliable Fire v. Arredondo, 2011 IL 111871, 965 N.E.2d 393, that the covenant (i) is not greater than required for the protection of a legitimate business interest, (ii) does not impose undue hardship on the employee, and (iii) is not injurious to the public;
  • Further codifies Reliable Fire by specifying that “whether a legitimate business interest exists is based on the totality of the facts and circumstances of the individual case,” including, but not limited to, “the near-permanence of customer relationships, the employee’s acquisition of confidential information through the employee’s employment, and time and place restrictions”;
  • Imposes notice requirements similar to those of the federal Older Workers Benefit Protection Act such as requiring employers to advise employees in writing to consult with an attorney before signing, and providing a copy of the convent agreement at least 10 business days before employment, or providing the employee 21 days to review the covenant before signing; and
  • Permits employees to recover costs and reasonable attorney’s fees if they prevail in an action initiated by an employer involving a covenant not to compete.

SB 3430 leaves some key questions unanswered – two questions that immediately come to mind are:  Does a “covenant not to compete” include client solicitation restrictions; and what qualifies as “some other fair and reasonable consideration”?  However, SB 3430 is the most thorough recent legislative attempt to govern covenants not to compete in Illinois.

We will keep tabs on these bills and apprise you of their progress.

A New London Connecticut Superior Court jury awarded an $839,423 verdict in November 2019, involving theft of trade secrets for a $70 million U.S. Navy underwater drone project. This case, LBI, Inc. v. Sparks, et al., KNL-cv12-6018984-S, is a classic example of the blatant theft of an employer’s confidential and proprietary information that is so easily traceable to electronic files – and the costly consequences for the defendant employer’s complicity in that trade secret misappropriation.

Plaintiff LBI, Inc., a small Groton-based research and design development company, was to design, build and test the Navy’s underwater drones, and LBI partnered with Defendant Charles River Analytics, Inc. to do the computer analytics. During the project, Defendant hired two of the Plaintiff’s employees who were subject to Plaintiff’s non-compete and non-disclosure agreements.

Plaintiff LBI proved that one of its former employees who was hired by the Defendant CRA had uploaded thousands of Plaintiff’s files to his personal Dropbox cloud-based file storage account while he worked for LBI. Soon after joining the Defendant CRA, he shared the uploaded materials with CRA, including accounting and engineering files, photographs and related designs and renderings used to fabricate and manufacture the unmanned vehicle buoys for the Navy underwater drone project.

The jury agreed with the Plaintiff LBI’s argument that the Defendant CRA began as a partner in the project, but became a competitor and committed tortious interference with the non-compete and confidentiality restrictive covenants between the Plaintiff LBI and its employees; and also, that the Defendant violated the Connecticut Unfair Trade Practices Act.

Confidential and proprietary trade secret information misappropriated by employees to their personal electronic devices and files is easily traced. Before and after hiring employees from a competitor, the hiring employer must scrutinize the source of what may be confidential and proprietary materials that the hired employee has misappropriated and is wrongfully misusing. Otherwise, the costly consequences for the malfeasant competitor-employer and former employee who steal those trade secrets are well justified.

Thomson Reuters Practical Law has released the 2019 update to “Non-Compete Laws: Connecticut,” a Practice Note co-authored with David S. Poppick and Carol J. Faherty.

See below to download it in PDF format—following is an excerpt:

OVERVIEW OF STATE NON-COMPETE LAW

1. If non-competes in your jurisdiction are governed by statute(s) or regulation(s), identify the state statute(s) or regulation(s) governing:

  • Non-competes in employment generally.
  • Non-competes in employment in specific industries or professions.

GENERAL STATUTE AND REGULATION

Connecticut has no statute or regulation that governs non-competes generally. Most non-compete agreements in Connecticut are governed by case law.

INDUSTRY- OR PROFESSION-SPECIFIC STATUTE OR REGULATION
Security Guards: Conn. Gen. Stat. Ann. § 31-50a
In the security industry, Conn. Gen. Stat. Ann. § 31-50a governs non-compete agreements.

Click here to download the PDF “Non-Compete Laws Connecticut.”