Why Restrictive Covenants Should Include Delaware Choice-of-Law and Forum-Selection Clauses

Many companies require high-level managers, salespeople, researchers and other key employees to sign confidentiality, non-solicitation and/or non-compete agreements, also known as “restrictive covenants.” These agreements are intended to prevent key employees from capitalizing on proprietary knowledge they learned or developed and relationships with customers and employees that they formed in the course of their employment for their own benefit or the benefit of competitors and against the interest of their former employers.

Well-drafted restrictive covenants include “choice-of-law” provisions that define which state’s law will be used to interpret the agreement and forum selection provisions that specify where the parties will litigate breaches of the contract. The Delaware Code, in 6 Del. C. § 2708, authorizes the parties to a contract that involves $100,000.00 or more to include a Delaware choice-of-law provision in their contracts, and states that the inclusion of such written provisions in an agreement “shall conclusively be presumed to be a significant, material and reasonable relationship with this State and shall be enforced whether or not there are other relationships with this State.”

Agreements that do not include choice-of-law provisions can be particularly problematic for companies with locations in several states, especially if those states do not have consistent approaches toward the enforcement of restrictive covenants. In the absence of choice-of-law and choice-of-forum provisions, the same contract language could wind up being enforceable in one state but not in another. California law, for example, prohibits enforcement of non-compete agreements altogether, and other states may refuse to enforce an agreement that a court deems to be overly restrictive, rendering the agreement useless.

Every company’s restrictive covenants should therefore specify one state whose law will govern the interpretation of the contract and whose courts will be used for any litigation that results from breaches of the agreement. There are several reasons why your company’s employment contracts should specify that Delaware law will govern and that disputes will be decided by Delaware state courts.

First, because Delaware is a “blue-pencil” state, specifying Delaware in the choice-of-law provision will maximize the likelihood that the agreement will be enforced. Even if the court decides that the duration of the agreement is too long, or the geographic scope is too wide, Delaware law allows the court to reduce the scope of the agreement and enforce it to the extent that the court deems reasonable. In addition, according to a study published by the U.S. Chamber of Commerce, Lawsuit Climate 2008: Ranking the States, “Delaware ranks first among all fifty states in the fairness of its litigation environment.”

Specifying Delaware state courts in the forum selection clause will also maximize the likelihood that the dispute will receive prompt and appropriate judicial attention. The Delaware Chancery Court is the nation’s leading forum for litigation of corporate issues. The court prides itself on responding quickly to the needs of business litigants and has a well-developed body of law on restrictive covenant issues.

Most restrictive covenant litigation begins with a motion for a temporary order restraining the former employee from violating the agreement. The employer finds out that the former employee has started a competitive business, or is behind the resignations of other key employees, or has accepted a position with a top competitor. The Delaware Court of Chancery can promptly issue orders that temporarily (pending trial) prohibit former employees from breaching their agreements not to solicit clients or employees, misappropriate confidential information, or compete.

The parties can agree in advance in the restrictive covenant itself that breaches of the agreement will create irreparable harm that should be remedied by such temporary injunctive relief. Even if the parties have agreed to arbitrate contract disputes, they should also agree that the Delaware Chancery Court is empowered to enter an injunction to maintain the status quo pending arbitration. This can be of critical importance to a business that would otherwise be subjected to increasing harm each day while the dispute moves through the arbitration process.

The Delaware Chancery Court does not hold jury trials. All matters are heard and decided by the judge (the Court has one Chancellor and four Vice Chancellors), reducing both delay and uncertainty. Other advantages include established precedents for enforcement of “fee-shifting” provisions that require employees who violate their restrictive covenants to pay the attorneys’ fees and costs that the employer incurs in connection with litigation over the agreement. To ensure that the case stays in the Chancery Court, the parties should agree that they will not remove cases from state to federal court and should include a provision shifting the fees and costs incurred to have the case sent back to state court to the party that moved the case to federal court.

The attorneys in Young Conawy’s Employment Law department can assist you to determine whether your company’s restrictive covenants can make use of the Delaware advantage.


2 responses to “Why Restrictive Covenants Should Include Delaware Choice-of-Law and Forum-Selection Clauses”

  1. Dawn says:

    In CA, however, courts have tended to invalidate such provisions as applied to California employees — and often this type of provision results in a “race to the courthouse.” If those who seek to invalidate the clause file in CA first seeking declaratory/injunctive relief, they often prevail.

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