Companies conducting business in more than one state frequently seek to select the state law that will govern the interpretation and enforcement of their contracts by including a choice of law provision in their agreements. One of the purposes behind using a choice of law provision is allowing a company to choose the law of a state with which the company is familiar and/or which a company feels will be more beneficial. Choice of law provisions are commonly contained in employment contracts and associated agreements, such as covenants not to compete. While choice of law provisions are frequently upheld, in certain circumstances, courts will refuse to apply them.
The Fifth Circuit Court of Appeals recently decided one such case: Cardoni v. Prosperity Bank. After Prosperity Bank acquired an Oklahoma-based bank, F&M Bank and Trust Company, it entered into employment contracts with several former F&M employees. These agreements included covenants not to compete and customer nonsolicitation agreements. Each of these contracts also contained a choice of law provision providing that Texas law would govern the conduct and enforcement of the contracts. Four bankers who worked in Tulsa, Oklahoma subsequently left Prosperity Bank to work for a competitor.
Prosperity Bank filed suit in Texas federal court seeking to enforce the covenants not to compete and nonsolicitation clauses under Texas law. The trial court determined that the choice of law provision selecting Texas law to govern the contracts was not enforceable as to the noncompetition and the nonsolicitation covenants and applied Oklahoma law in determining that these covenants were not enforceable. Prosperity Bank appealed the decision to the Fifth Circuit.
The Fifth Circuit observed that, as a general rule, choice of law provisions are enforceable. The Fifth Circuit noted, however, that courts will not enforce a choice of law provision if the state whose laws apply does not have a substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties’ state law choice. Courts will also not enforce a choice of law provision if the application of law of the chosen state would be contrary to the fundamental policy of the state that has a greater interest in the determination of the dispute at hand. Effectively, if the state with the most interest in the dispute has a public policy that would bar or prevent the enforcement of the disputed covenant or agreement, even if such an agreement would be enforceable under the chosen state’s law, the chosen state’s law will not be applied.
In evaluating this case, the Fifth Circuit first determined that Oklahoma had a greater interest than Texas in the determination of the issues presented to the court. The four bankers involved were employed in Oklahoma, almost 100 percent of their work occurred in Oklahoma. They did not do any work in Texas, and they did not sign their contracts in Texas.
Regarding the noncompete agreement, the court found that the application of Texas law would violate a fundamental policy of Oklahoma regarding the enforcement of noncompete agreements. More particularly, Oklahoma law specifically barred the enforcement of noncompete agreements except in the sale of goodwill and dissolution of partnerships. Oklahoma law also prohibited courts from reforming unenforceable covenants not to compete. Therefore, even if the covenant between Prosperity Bank and the bankers would have been enforceable under Texas law, because of Oklahoma’s more significant relationship to the dispute and Oklahoma’s public policy disapproving of noncompete agreements, the Fifth Circuit determined that the trial court properly applied Oklahoma law—and not Texas law—in denying the preliminary injunction to enforce the noncompetition agreements.
However, as to the customer nonsolicitation agreements, the Fifth Circuit found that Oklahoma did not have a fundamental policy prohibiting enforcement of nonsolicitation agreements. While Oklahoma law is narrower than Texas law regarding the enforceability of nonsolicitation agreements, the mere fact that the Oklahoma law is narrower than Texas law does not establish a fundamental policy that would prevent the application of Texas law. Importantly, the application of the nonsolicitation policy would not prevent residents of Oklahoma from earning a living–consistent with Oklahoma’s fundamental policy regarding nonsolicitation agreements. Therefore, applying Texas law to determine the enforceability of the nonsolicitation agreement would not offend a fundamental policy of Oklahoma law, and the choice of law provision was enforceable as to the nonsolicitation agreement.
The Fifth Circuit’s decision provides an important reminder to Texas employers that conduct business in foreign states that a choice of law provision selecting Texas law might not be enforced. Employers should evaluate the laws of the states in which their employees will be working to determine if these states’ laws on important issues, such as covenants not to compete, are the same as Texas’s law. If these laws differ dramatically from Texas law, an employer should determine if the law of the other states reflects a fundamental policy that would prevent application of the Texas choice of law provision. Finally, in order to improve the chances that a Texas choice of law provision will be enforced, employers should try to structure transactions and the responsibilities of employees working outside of Texas) to provide them with more contact with or nexus to Texas. Steps could include executing agreements in Texas, conducting business in Texas, holding meetings in Texas, and assigning duties in Texas.