Post-employment non-compete covenants are generally invalid in California, with certain limited but important exceptions like when a business or associated goodwill is sold and the buyer – as part of the deal – wants to prohibit certain sellers from competing with their former business.
Consequently, buyers of California-based businesses generally assume they can’t contractually tie non-compete restrictions of California-based employees to the end of the parties’ employment relationship. Sometimes, however, parties to M&A transactions attempt to circumvent California’s hostility to post-employment non-compete covenants by entering into such restrictive covenants with sellers who are also employees of the selling entity. Such arrangements purport to bind the seller/employee from competing with the sold business after the employee’s termination or sale of shares in the entity and typically provide for the application of the law of a state that – unlike California – is more amenable to the enforcement of post-employment non-competes, such as Delaware.
A recent Delaware case, however, highlights the difficulty of enforcing non-competes against Californians, even where the parties agree that the non-compete is governed by the law of a different state. This is especially true where there is no meaningful relationship between the former employee who wishes to compete and the state whose law is chosen by the parties to govern the contract or in which disputes must be heard. Parties wishing to sidestep California’s widespread disfavor of non-competes through choice of law or choice of venue provisions should heed this recent Delaware ruling (among other recent developments in this area) when considering such provisions.
Delaware Court Declines to Enforce Delaware Non-Compete in California
In EBP Lifestyle Brands v. Boulbain, the Delaware Court of Chancery declined to enforce covenants not to compete or solicit employees against Yann Boulbain, a former vice president of The Ergo Baby Carrier, Inc., a company based in California, due to lack of personal jurisdiction. Specifically, the court found that although the restrictive covenants were contained in a stockholders agreement that was governed by Delaware law, and the company’s ultimate parent and party to the agreement was incorporated in Delaware, such “contacts” between the former employee and the State of Delaware were not, in and of themselves, sufficient to establish personal jurisdiction over the former employee in a Delaware court. In the alternative, the court also noted that Delaware conflicts of law principles would have required dismissal of the case in any event since California had a materially greater interest in the dispute (such that California – and not Delaware – law would have governed the court’s analysis of the restrictive covenants).
Yann Boulbain was VP of global sales at Ergo until his employment terminated in late 2016. After he left, Boulbain signed a stockholders agreement containing the non-compete and employee non-solicitation restrictive covenants as a prerequisite to exercising stock options for shares in Ergo’s parent, EBP Lifestyle Brands. In spring 2017, Boulbain accepted a position as CEO of Petunia Pickle Bottom and Moby Wrap, both California-based competitors of Ergo. Moreover, Boulbain allegedly solicited several of his former colleagues at Ergo to work for the new companies. The parent of Ergo sought an injunctive order to enforce the non-compete and non-solicit covenants against Boulbain in the Delaware Court of Chancery.
The court dismissed the claims, ruling that personal jurisdiction was lacking under both Delaware’s long-arm personal jurisdiction statute and the due process clause of the Constitution. To establish personal jurisdiction under the statute, EBP had to show that Boulbain transacted some type of business in Delaware and that his alleged breaches of his non-compete and non-solicit covenants arose from those specific transactions. The court found that even though Boulbain owned shares in EBP, a closely-held Delaware corporation, and entered into a stockholders agreement with a Delaware choice of law provision, those Delaware-related contacts were not enough for Delaware to exercise personal jurisdiction over Boulbain with respect to the non-compete dispute.
More specifically, the court found that Boulbain did not engage in any activities or actions in Delaware sufficient to permit application of Delaware’s long-arm statute. Boulbain, among other things, had no hand in negotiating the form stockholders agreement that he was asked to sign, lived and worked in California, had never visited Delaware and did not own any property in Delaware.
Further, the court also held that Boulbain’s actions in his capacity as VP of global sales for Ergo could not be imputed to him for purposes of establishing significant contacts in Delaware under the so-called “fiduciary shield doctrine,” which provides that an employer’s acts may not be imputed onto a fiduciary or employee of the corporation when such individual is merely carrying out his/her duties. The court further found personal jurisdiction lacking under due process because Boulbain’s actions did not establish a significant connection between Boulbain’s purported specific breaches (i.e., accepting a position with a California competitor and soliciting former colleagues in California) and the forum state of Delaware.
While the court dismissed the action on these jurisdictional grounds, it also suggested that – even if personal jurisdiction had been established – the court would have nonetheless dismissed the case on the pleadings based on conflicts of law principles. Specifically, the court cited to its decision Ascension v. Underwood (Del. Ch. 2015), in which the court declined to enforce a non-compete after determining under conflicts of laws principles that California had a materially greater interest in the dispute than Delaware had, notwithstanding a Delaware choice of law provision, such that California law (and not Delaware law) should control the court’s analysis of the restrictive covenant in question. In that case, the non-compete was between a California resident who worked in California and a Delaware LLC that was based in California, the noncompete was negotiated in California, executed in California and allegedly violated in California. The Ascension court explained that while Delaware law generally favored the parties’ freedom to contract for a governing law, that interest was trumped by California’s strong public policy against non-competes when California had the greatest contact to the non-compete at issue.
As if that were not enough, the court then noted that Boulbain’s non-compete was also likely void – even under Delaware law – due to its broad scope (prohibiting conduct “anywhere in the world”) and duration (prohibiting conduct for a period of two years after Boulbain disposed of his shares, which was contingent upon the entirely discretionary approval of EBP’s majority stockholder).
The decision serves as a clear warning to parties that, regardless of choice of law, it will be very difficult to enforce a non-compete against an individual in California in a simple stockholder purchase agreement under a statutory exception where (as here) the individual is merely purchasing, and not selling, stock. This is especially true where the person has no meaningful ties to or contacts with Delaware. Whether there are sufficient Delaware contacts will be a highly fact-specific inquiry for the Delaware court. (As a procedural matter, it is also worth noting that a California resident accused of breaching a covenant not to compete can always go into a California court preemptively to seek a declaratory judgment that the non-compete is unenforceable.)
New California Labor Code Restricts Forum-Selection Clauses
Employers also need to be careful about requiring California employees to sign a standard non-compete clause with a forum selection clause that specifies a forum outside of California. Under a recent California statute (i.e., Section 925 of the California Labor Code) that went into effect in January 2017, potential penalties may apply if an employer requires a California employee who primarily works and resides in California to sign “as a condition of employment,” an agreement with a provision (e.g., a forum selection or choice of law provision) that requires the employee to adjudicate disputes arising in California in a forum outside of California or under the law of another state.
While there is an argument that stockholder purchase agreements, like the one at issue in Boulbain, are voluntary and thus not required “as a condition of employment,” a stockholder agreement that is signed by a stockholder who is also an employee may have a greater risk of falling within the reach of the law. Until there is more specific guidance on this matter, employers should be aware that the provision may be voidable by the employee and that the employee may seek injunctive or other available remedies, such as attorney’s fees and monetary penalties under the labor code. Note, however, that the statute is not applicable if the employee is individually represented by legal counsel and the employee’s lawyer is involved in negotiating the terms of the forum selection or choice of law clause applicable to employment disputes.