Choice of Law Has Huge Consequences, Especially in NC Non-Compete Case

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An interesting case out of the Eastern District of North Carolina reminds us of the importance of choice of law when dealing with non-compete litigation. Let’s take a look:

In December 2009, Associated Hygienic Products (“AHP”) hired James DeFelice as the Director of Purchasing.  AHP makes disposable diapers.  This is a huge and growing market dominated by major players like Proctor & Gamble and Kimberly Clark.  At the time of his hire, DeFelice signed an employment agreement that contained non-compete, non-solicitation and non-disclosure provisions.  In relevant part, the non-compete restriction only applied to the United States.  In June 2013, Domtar AI Inc. (“Domtar”) acquired AHP.  Shortly thereafter, DeFelice notified Domtar and AHP that he was resigning and going to work in Canada for J.D. Irving (“JDI”), a rival in the baby diaper product market.  When DeFelice began working for JDI, Domtar sued alleging breach of the employment agreement, unfair competition, unfair and deceptive trade practices, violations of North Carolina’s Trade Secrets Protection Act and other claims.  Domtar’s case, in brief, was that even though now working in Canada, DeFelice was violating his non-compete agreement and would inevitably disclose the company’s trade secrets to his new employer.  And that JDI was in on the deal because it was all a huge conspiracy designed to inflict harm on Domtar.  Standard fare.

Shortly after initiating the litigation, the plaintiff moved for a preliminary injunction.  The Court denied that request.  Three months after denying the plaintiff’s motion for a preliminary injunction, the case is over.  The Court granted judgment as a matter of law for the Defendants.

Remember Choice of Law

First, the court analyzed the breach of contract claim against DeFelice.  In today’s world, it seems odd to see a contract without a choice of law provision.  But apparently that’s what happened here.  The employment agreement (“the Agreement”) between AHP/Domtar and DeFelice was utterly silent as to choice of law.  So here we go: A federal court sitting in diversity applies the choice of law rules of the state in which it sits.  Under North Carolina law, absent evidence of some other intent (e.g. a contractual choice of law provision), the applicable standard is lex loci contractus.  The law of the place where the contract was formed will govern.  The Agreement was prepared by AHP in Georgia, presented to DeFelice in Georgia during his employment in Georgia and signed by both parties in Georgia.  As a result, Georgia law applies.

Now the funny thing about Georgia law of restrictive covenants is that Georgia law is fairly ruthless when dealing with restrictive covenants that are unreasonable.  In many states, if a non-compete agreement, as drafted, is unreasonable in temporal or geographic scope, the court will simply “blue pencil” the agreement to make it reasonable.  In other words, if the restricted geographic territory is too broad, the court will narrow it.  If the restricted term is too long, the court will shorten it. Many states do things this way.  But not Georgia.  In Georgia, if the time or territory is unreasonable, then that  term can be struck.  And a restrictive covenant with no temporal or geographic limitation is utterly unreasonable and unenforceable.  The obvious public policy behind Georgia law is to prevent companies from drafting unreasonable restrictive covenants (which are already an exception to the rule that restraints of trade are disfavored). 1

In the case at bar, the Agreement – as drafted – indicated that the restricted territory was the United States.  But – again – DeFelice was working in Canada.  So the plaintiffs argued that the non-compete applied to Canada as well, because DeFelice – though in Canada – could still be competing with Domtar/AHP’s US operations.  The court essentially accepted Domtar’s proffer that the non-compete was intended to apply not only throughout the U.S. but also to Canada and – in fact – worldwide.  Having accepted this argument, the court held that a worldwide non-compete provision – with no geographic limitation – was unenforceable. As a result, the non-compete provision was void as a matter of law.  But wait, there’s more: The Agreement also contained non-solicitation and non-disclosure restrictions.  As mentioned previously, Georgia law on this point is harsh: If one restrictive covenant contained in an agreement is stuck because it is unreasonable, all restrictive covenants contained in the agreement are unenforceable.  As a result, Domtar had nothing left to enforce: The non-compete, non-solicitation and non-disclosure provisions were all void. The court entered judgment on the pleadings for DeFelice because the plaintiff had failed to state a claim.

Trade Secrets, Geography & More Choice of Law

Next, the court addressed the trade secret claim.  From what I gather, the Plaintiff Domtar had not alleged that DeFelice misappropriated any specific trade secrets.  Instead, their claim was based on the contention that DeFelice had access to their trade secrets while working for AHP and that he would inevitably disclose those secrets to his new company.  Plaintiffs brought this claim under North Carolina’s Trade Secrets Protection Act.  But the defendants countered that North Carolina’s TSPA did not apply. Again, back to choice of law: The court is sitting in North Carolina and applies North Carolina choice of law.  For a trade secret claim, the applicable principle is lex loci delicti – the law of the place of the wrong.  In this case, DeFelice left AHP, moved to Canada and began working for JDI.  This raises an question: Where is the place of the wrong when the claim is misappropriation of trade secrets?  Noting that North Carolina law was sparse on this point, the court surveyed the law of several other jurisdictions and concluded that the place of the wrong is where the misappropriation and use actually occurs.  In some cases, that still could be a tough question to answer.  But in this case, it was simple: There were no allegations that the defendants did anything in North Carolina.  Instead, the trade secret claim was built solely on speculation about threatened misappropriation in Canada.  As a result, North Carolina’s TSPA could not apply to the conduct at issue and the plaintiffs could not state a claim under that Act.

The court made short work of the other claims.  The unfair trade practices claim was dismissed under a sort of preemption doctrine.  North Carolina courts have held that when the core of a dispute is contractual, the plaintiff cannot tack on an unfair trade practices claim absent “substantial aggravating circumstances.”  Such circumstances were absent here.  The tortious interference claim against JDI was gone because all relevant parts of the Agreement between DeFelice and the plaintiff were void.  And as for the conspiracy claim, everything else had been dismissed, so there was nothing to conspire about.

The Takeaways

(1) State Law Trumps: In non-compete litigation, perhaps more than in any other substantive area of law, differences in state law are of paramount importance.  The state law makes the case.  If you litigated three non-compete cases with identical facts under Florida, Georgia and New York law, you would probably reach three entirely different outcomes.  I have seen some Florida courts that would have bought the Plaintiff’s argument—- that the non-compete should apply to activity in Canada because it amounts to competition with ADH/Domtar in the US.  And certainly, Florida courts would have looked to enforce the non-solicitation and non-disclosure restrictions.  This principal – about the importance of differences in state law – applies to other related doctrines such as inevitable disclosure.

(2) Remember Your Choice of Law: I mean this in two respects.  First, lock it down contractually.  Have a choice of law provision so you have certainly regarding what state law will apply.  But beyond that, understand the general principles at play—- For instance, you cannot contractually select a state law that has no connection – or only a minor connection- to the parties.  That would result in a court invalidating the contractual choice of law provision and doing its own analysis of what law should apply.  This case also touched upon choice of law as to tort or misappropriation.  North Carolina is a lex loci delicti state.  But the overwhelming majority of states have abandoned that doctrine.  Bottom line: Understanding choice of law and conflicts of law principles is extremely important.

(3) Inevitable Disclosure is in Decline: Let’s step away from the non-compete issue and focus on the trade secret claim.  In many trade secret cases, the plaintiff does not have a claim for actual misappropriation.  They do not allege that the defendant actually stole trade secrets and is now using those secrets against them.  Instead, they claim that the defendant previously had access to their trade secrets and inevitably will disclose those secrets in the course of working for a competitor. This is the inevitable disclosure doctrine, a doctrine that was essentially created by the Seventh Circuit in PepsiCo v. Redmond, 54 F.3d 1262 (7th Cir. 1995). From the time Redmond was decided and for perhaps the next ten years, it was the heyday of inevitable disclosure. A number of courts throughout the country followed suit and adopted some form of the inevitable disclosure doctrine. In my view, the tide has turned. Washington recently rejected the inevitable disclosure doctrine in an important case involving Amazon and Google. And courts in other states like North Carolina and Georgia have issued decisions criticizing the doctrine and strongly limiting its applicability.

The case is Domtar AI Inc. v. J.D. Irving, Ltd., 2014 WL 4162440 (E.D.N.C. Aug. 20, 2014)

1 Georgia enacted its new Restrictive Covenants Act in 2011, which altered the playing field.  The old law, O.C.G.A. § 13-8-2, prohibited courts from blue-penciling overbroad restrictive covenants.  The new law, O.C.G.A. § 13-8-50, allows courts the option to blue-pencil but does not make it mandatory.  The new law is not retroactive.  As a result, the old law - no blue penciling - generally applies to all contracts entered prior to January 1, 2011.  Although the court applied the old law in this case, it could have reached the same result under current Georgia law.

Topics:  Choice-of-Law, Non-Compete Agreements, Restrictive Covenants

Published In: Civil Procedure Updates, Civil Remedies Updates, General Business Updates, International Trade Updates, Labor & Employment Updates

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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