Arbitrators, Not Judges, Must Decide Whether Noncompetes Are Enforceable if There is an Arbitration Clause, Says U.S. Supreme Court

by BakerHostetler
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On November 26, 2012, the United States Supreme Court held that the enforceability of a noncompete agreement containing a valid arbitration clause must be determined by an arbitrator in the first instance, not by a federal or state court. Nitro-Lift Technologies, LLC v. Howard et al., 568 U.S. ___ (2012). The U.S. Supreme Court unanimously chastised the Supreme Court of Oklahoma for ignoring the federal policy in favor of arbitration under the Federal Arbitration Act (FAA) on disputes involving noncompete agreements. The interplay of arbitration and court proceedings has always played an integral role in noncompete disputes. This decision will significantly impact the strategy and tactics used in noncompete disputes going forward.

In Nitro-Lift, the company demanded arbitration after two employees resigned and began working for a competitor. In response, the former employees went to court seeking a declaration that their non-competition agreements were null and void, as well as an injunction preventing enforcement. The court dismissed the case because of the arbitration clause. The Oklahoma Supreme Court reversed that decision, rejecting the company's argument that the FAA required that an arbitrator decide whether the noncompete agreements were enforceable. Instead, the Oklahoma Supreme Court held that the noncompete agreements were "void and unenforceable as against Oklahoma's public policy."

The United States Supreme Court offered a stern reprimand to the Oklahoma Supreme Court and observed that the FAA declares a "national policy favoring arbitration," that it was "well settled" that the substantive law created by the FAA applies in state court, and that the Oklahoma Supreme Court was bound by the FAA, "the supreme Law of the Land." The U.S. Supreme Court flatly rejected the argument that Oklahoma's specific statute "addressing the validity of covenants not to compete, must govern over the more general statute favoring arbitration." This decision now clearly requires that in noncompete cases the FAA is "the supreme Law of the Land" and it controls over state laws governing noncompetes where the agreement contains an arbitration clause. Going forward, arbitrators, not courts, must decide issues regarding the enforceability of noncompete agreements containing valid arbitration clauses.

The United States Supreme Court's decision in Nitro-Lift presents a couple of interesting legal issues:

  • If a party does not assert an FAA defense, may the state court then take the liberty of interpreting the underlying contract without leaving that determination to the arbitrator?

    The answer likely is "yes." The party seeking to take advantage of an arbitration clause should assert its reliance upon the FAA in making a demand for arbitration and in opposing any attempt by the other party to have a court decide the dispute. The failure to assert reliance upon the FAA could be deemed a waiver of the right to arbitrate.
     
  • If a particular state's law does not favor the enforcement of noncompete agreements, can this problem be overcome by inclusion of an arbitration clause?

    The answer likely is "no," but it is possible. While arbitrators will be likely to apply a particular state's law to the parties' dispute, it is possible that they may do so in a way that varies from existing unfavorable court decisions by distinguishing the circumstances in the case before them or, perhaps, they may decide that another state's (more favorable) law should apply.
     
  • If the noncompete agreement and arbitration clause does not contain a "carve-out" allowing the employer to seek injunctive relief in court, does the U.S. Supreme Court's decision in Nitro-Lift bar the employer from suing in court for injunctive relief pending arbitration?

    The answer is uncertain. While a number of courts have permitted injunctive relief pending arbitration, this view is not unanimous, and it remains to be seen whether the Nitro-Lift decision will change the prevailing view. In order to preserve the right to seek injunctive relief, it is recommended that the issue specifically be addressed in the arbitration clause. In the absence of language permitting the employer to seek injunctive relief in court, an employee could assert his/her reliance upon the FAA in opposing such an action. In any event, as noted above, the failure to assert reliance upon the FAA could be deemed a waiver of the right to arbitrate.

If you have any questions about the material presented in this Alert, please contact David A. Posner ( dposner@bakerlaw.com or 216.861.6113); John Siegal ( jsiegal@bakerlaw.com or 212.589.4245); or any member of the BakerHostetler Noncompete and Trade Secrets Team.

Authorship Credit: Dawn Kennedy, David A. Posner, and John Siegal


 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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