Duplicative Non-Compete Provisions in Employment Contracts Might Defang Choice of Forum Provisions in Corporate Formation Documents

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Repetition is not always a rhetorical virtue. Delaware entities seeking to enforce non-compete provisions exclusively in Delaware courts have now been warned: Including non-compete agreements in employment contracts with employees who work in a state that will not enforce choice of law or forum provisions in employment contracts may hinder enforcement of all restrictive covenants. As a result, companies should consider including the non-compete only in their corporate formation documents, and not in employment contracts with employees in such states.

Background

Vice Chancellor Joseph R. Slights III of the Court of Chancery of the State of Delaware issued a letter opinion last week in AG Resource Holdings, LLC, et al. v. Thomas Bradford Terral, case number 2020-0850JRS, demonstrating the potential consequences of including duplicative or overlapping non-compete provisions in employment contracts.

AG Resource Holdings, LLC (“Company”) is a Delaware company that terminated Thomas Terral—a co-founder of the Company who served as its Chief Executive Officer, Chief Operating Officer, and Executive Chairman and worked in its Louisiana offices—for cause because he was secretly plotting to compete with the Company or attempting to steal the Company’s business. The Company alleged that Mr. Terral’s conduct violated the Company’s LLC Agreements, which included a non-compete provision and a provision requiring Mr. Terral to act in good faith. The LLC Agreements contained a Delaware choice of law provision and selected Delaware courts as the exclusive forum to litigate disputes arising from a breach of the LLC Agreements.

Mr. Terral’s employment agreement with the Company, however, included a duplicative non-compete provision and other restrictive covenants, including a non-solicitation provision, a non-disparagement provision, a non-interference provision, and an agreement not to disclose confidential information. The employment agreement included a Delaware choice of law provision but was silent as to the forum in which disputes must be litigated.

Mr. Terral initiated litigation by filing suit in Louisiana. He sought a declaration that the non-compete provision in his employment agreement was unenforceable under Louisiana law and that the selection of Delaware law in the employment agreement was null and void. Mr. Terral also sought an injunction preventing the Company from enforcing the non-compete provision in the employment agreement. Four days later, the Company filed an action against Mr. Terral in Delaware, alleging that Mr. Terral breached his employment agreement and his obligations under the LLC Agreements. In addition to seeking damages for breach of contract, the Company sought an order enjoining Mr. Terral from continuing to breach his agreements.

A flurry of motion practice then proceeded simultaneously in Louisiana and Delaware, with each side attempting to force the other party to litigate in its preferred forum. The Louisiana court struck first: it denied the Company’s motion to stay and granted Mr. Terral’s motion for preliminary injunction, holding that the Delaware choice of law provision in the employment agreement was null and void under Louisiana law and that the non-compete was likely unenforceable. This ruling was perhaps partially expected, because a Louisiana statute expressly provides that choice of forum or law provisions in employment contracts are null and void.

The Delaware court issued its opinion last week. The Vice Chancellor first considered the claims asserted under the employment agreement. The court ruled that the Louisiana action was not entitled to any “first-filed” deference because it was filed just four days before the Delaware action, and the two matters included mirror-image requests for relief. The court thus treated the actions as simultaneously filed and applied a widely-used five-factor test to determine which forum was most appropriate. The court focused on the fact that the Louisiana court had already ruled that the non-compete provision in the employment contract was likely unenforceable and that the choice of Delaware law was null and void—a decision that should be afforded deference in order to avoid competing or confounding rulings in separate courts.

The Delaware court then applied a choice of law analysis and determined that Louisiana had a compelling interest in enforcing the employment rights of its citizens who work in that state. Although the Company had argued that c-suite executives like Mr. Terral should be treated differently than run-of-the-mill employees—because his conduct affected the internal affairs of a Delaware entity, which Delaware courts indisputably had an interest in protecting—the court opted not to “dwell” on this argument, brushing it aside with other factors that “do not push the needle toward either Louisiana or Delaware.”

For these reasons, the Delaware court determined that Louisiana was “best suited to address the claims under the Employment Agreement,” and it stayed the Company’s claims based on that agreement. Nonetheless, the court left the door slightly ajar, clarifying that the claim was merely stayed (and not dismissed), such that the parties could return to Delaware if the claim was not “fully resolved” in Louisiana. The Court recognized that the Company’s claims for breach of the restrictive covenants under the LLC Agreements were “a different story.” As the Vice Chancellor explained, whether Mr. Terral violated the LLC Agreements presented an issue of internal governance and fiduciary obligations owed to Delaware entities and were not subject to Louisiana statutory law. The Company thus had “every right to litigate those claims in its choice of forum.” But that did not necessarily free the Company from less favorable Louisiana law.

Rather, the dueling rulings in Louisiana and Delaware have resulted in a split action, with the claim for breach of the employment agreement proceeding in Louisiana, and the claim for breach of the LLC Agreements proceeding in Delaware. But like the proverbial baby, these two causes of action cannot easily be split in half: the same conduct that results in a breach of the restrictive covenants in the employment agreement could also amount to a breach of the overlapping restrictive covenants in the LLC Agreements. The Delaware court expressly acknowledged this overlap, stating, “I acknowledge there may be some overlap in the litigation and adjudication of claims arising under the Employment Agreement on the one hand, and the LLC Agreements on the other, and further acknowledge there is at least some risk of inconsistent outcomes.”

As a result of this acknowledged overlap, the parties are now in a race to obtain a judgment in their preferred forum. And the prevailing party in that race will almost certainly argue that the judgment should be given preclusive effect in the other forum. Thus, in addition to facing litigation risk, the Company is incurring duplicative litigation costs and the possibility that an adverse ruling in an employee-friendly jurisdiction might be used with preclusive effect against the Company in Delaware. And an adverse ruling in Louisiana could also very publicly put at risk the enforceability of its agreements with other employees, particularly those who may have a small ownership interest and be subject to the restrictions in the LLC Agreements, but whose conduct would be less central to the internal affairs of the Company and Delaware’s interest in corporate governance.

This begs the question: would the courts have reached a different result if the Company opted to include the non-compete and forum selection provisions solely in its LLC Agreements (but not the employment agreement), such that a breach of the non-compete could be litigated exclusively in Delaware courts? It appears that by duplicating the non-compete provision in the employment agreement, the Company provided its employee with an avenue to dispute the legitimacy of the restrictions in his preferred forum.

These decisions thus provide an important lesson in drafting: Deal lawyers should consider carefully whether to include duplicative provisions across multiple different documents or whether to limit certain provisions to governance documents—particularly in Delaware, where choice of law and forum provisions will be respected and where reasonable covenants are likely to be enforced. One factor to consider is whether the state in which the employee works treats restrictive covenants (and choice-of-law and forum provisions) with hostility or instead generally enforces them; if the latter, then the belt-and-suspenders approach might be prudent, but if the former, duplication might do more harm than good. 

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