High Court Vacates State Supreme Court’s Arbitration Ruling in Noncompete Case

This morning, the U.S. Supreme Court, in a per curiam opinion, ruled that the Oklahoma Supreme Court failed to adhere to a correct interpretation of the Federal Arbitration Act (FAA). The Court vacated a decision made by the state high court, ruling that noncompetition agreements in two employment contracts were null and void. According to the Court, it was for an arbitrator, and not the state court, to decide whether the covenants not to compete were valid as a matter of state law. Nitro-Lift Technologies, L.L.C. v. Howard, No. 11–1377, U.S. Supreme Court (November 26, 2012).

Factual Background

The underlying decision involved two employees, Eddie Lee Howard and Shane D. Schneider, who worked for Nitro-Lift Technologies, L.L.C. Howard and Schneider entered into a confidentiality and noncompetition agreement with Nitro-Lift that contained an arbitration clause. When Howard and Schneider left the company to work for one of Nitro-Lift’s competitors, the company served them with a demand for arbitration. In response, the workers filed suit asking the court to declare their agreements null and void.

The Oklahoma Supreme Court, citing a state law limiting the enforceability of noncompetition agreements and despite a series of U.S. Supreme Court cases interpreting the FAA, held that the “existence of an arbitration agreement in an employment contract does not prohibit judicial review of the underlying agreement.” As a result, the state’s highest court found that the arbitration clauses in the contracts were not an obstacle to its review of the case and held that the agreements were void and unenforceable.

Legal Analysis

In vacating the Oklahoma Supreme Court’s decision, the U.S. Supreme Court relied on its prior decisions construing the FAA. The Court first distinguished the validity of the contract from the validity of the arbitration clause within the contract, ruling that “it is a mainstay of the Act’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 or state court.” The validity of the arbitration provision, the Court found, is subject to court determination, while the validity of the contract—assuming that the arbitration provision is valid—is subject to the arbitrator’s decision.

Contrary to this procedure and despite the fact that the trial court found that the contract contained a valid arbitration clause, the Court ruled that the Oklahoma court “assumed the arbitrator’s role by declaring the noncompetition agreements null and void.” “Our cases hold that the FAA forecloses precisely this type of ‘judicial hostility towards arbitration’,” the Court ruled and vacated the judgment of the Supreme Court of Oklahoma.

Practical Impact

According to Tobias E. Schlueter, a shareholder in Ogletree Deakins’ Chicago office: “There is a straightforward lesson in this decision. Restrictive covenant disputes subject to valid arbitration agreements must be decided only in arbitration without regard to the nuances or idiosyncrasies of the courts in any forum state. Prior to this decision, companies could make strategy decisions at the time of enforcement about whether to assert that the substantive enforceability of a restrictive covenant can be decided by a court instead of an arbitrator. As a practical matter, that decision is no longer available. Companies must decide whether they really mean to arbitrate non-competition disputes. The answer will depend on numerous factors, including the relative hostility to restrictive covenants in the forum state (i.e., will the company have better practical odds with an arbitrator instead of a court) and the company’s risk tolerance.”

Hera S. Arsen, J.D., Ph.D., is a senior editor of firm publications in the Torrance, California office of Ogletree Deakins.