Earlier this week, we discussed how when drafting or reviewing a restrictive covenant, few are likely to devote any significant attention to the provisions in the “Miscellaneous” section of the agreement, and how this is a significant mistake. In particular, we discussed how forum selection clauses are extremely important when drafting restrictive covenant agreements.
In this post, we are considering Choice of Law and Arbitration provisions.
Restrictive covenant agreements frequently provide that disputes related to the agreement are to be governed by the law of a particular, identified state. This is a benefit in a lot of ways because it creates predictability for the contracting parties. Unfortunately, many employers who have operations in many different states use one form agreement everywhere. This presents a problem.
Many courts are reluctant to enforce the parties’ choice of law if the choice of law is contrary to the law in which the court is located. For example, an employer headquartered in New York could find itself trying to enforce its form restrictive covenant agreement in Virginia against an employee who was employed in that state. The restrictive covenant agreement could provide for New York choice of law, since that is the state where the employer is located.
If the agreement is overbroad, the Virginia court may choose to disregard New York law and apply Virginia law in order to find that there is no enforceable restrictive covenant. Remember—unlike New York, Virginia doesn’t allow a court to revise an overbroad covenant (known as “blue penciling”). This would be a bad result for the employer.
Further, keep in mind that courts generally won’t enforce a choice of law provision if it has no relationship to either the parties or the forum. So, and employer cannot just try to apply the most favorable state law to it in all of its agreements.
In the relatively recent Supreme Court decision in Nitro-Lift Technologies, L.L.C. v. Howard, 568 U.S. ___ (2012), the Court overturned a ruling by the Oklahoma Supreme Court that permitted judicial review of a non-compete provision despite the contract’s arbitration clause. So, there is no question that breaches of restrictive covenants can be arbitrated. But should they be?
Arbitrating a claim for money damages arising out of a breach of a non-compete may be preferable because (1) arbitration is typically faster and less expensive (though costs are rising) than a trial at the courthouse, and (2) arbitrations are private proceedings.
But, obtaining injunctive relief (such as a Temporary Restraining Order or Permanent Injunction) in an arbitration proceeding is often problematic. Injunctive relief typically takes far longer to obtain in arbitration than it would at the courthouse where parties can seek immediate (at least temporary) relief. In addition, arbitrators lack contempt power to enforce the injunctive relief they grant. A party who ignores an arbitrator’s order does not face jail like a party who ignores a court order.
Common advice suggests that employers and other parties who wish to arbitrate non-compete claims should draft an exception in the arbitration clause allowing them to pursue injunctive relief through the courts. However, this may not be the best idea because many states find that an agreement drafted that way is one-sided, unfair contract of adhesion, and, accordingly, treated as invald from the outset (“void ab initio,” to use the fancy Latin courts and lawyer enjoy).
For example, in the case of Tatum v. ProBuild Co., No. Civ. 12001060 LH/LFG (D.N.M., July 17, 2013), Tatum, an employee of ProBuild, purportedly blew the whistle on her subordinate for allegedly stealing from their employer. Shortly thereafter, she was fired, but alleged similarly situated male employees were not. She filed a gender discrimination lawsuit in a New Mexico state court. ProBuild removed the case to federal court, and then moved to compel arbitration based on the mandatory arbitration clause in ProBuild’s employment agreement.
The mandatory arbitration clause in the employment agreement provided that equitable relief could be sought in a court for violation of the non-competition, non-solicitation, and confidentiality covenants in the agreement. The court found that the employment agreement was therefore unconscionable, and refused to enforce it, allowing the employee’s gender discrimination case toproceed in court—not arbitration.
What if the agreement at issue had been a restrictive covenant rather than an employment agreement? The employer could lose the benefit of the entire agreement and be forced trying to shoehorn its claim into other causes of action.
Don’t assume that the provisions in the “Miscellaneous” section of your restrictive covenant agreements don’t matter. You must review and draft them with the same care as every other portion of your restrictive covenant.