Last week, the Delaware Chancery Court in Ascension Insurance Holdings, LLC v. Underwood refused to grant injunctive relief to a Delaware company seeking to enforce a non-compete agreement against a California resident. In that case, Mr. Underwood, a California resident, participated in a sale of business assets and their associated goodwill to the Delaware company. As part of this transaction, Mr. Underwood signed an asset purchase agreement and an employment agreement. Both agreements contained restrictive covenants preventing Mr. Underwood from competing with the Delaware company for a period of time after the sale closed and after his employment with the company ended. Although the Delaware company did business exclusively in California, the agreements each contained a “choice of law” provision requiring that any provisions at issue under the agreement be interpreted and governed by Delaware law.
Mr. Underwood allegedly breached the non-competition covenant and the Delaware company sued to enforce it. Delaware law generally allows parties to freely choose what law will apply to an agreement. Moreover, Delaware law also will enforce reasonable non-competition agreements. As for California, although its Business & Professions Code prohibits non-competition arrangements, there is a carve-out for circumstances involving the sale of business assets and goodwill. Based on this, it seems that the non-competition agreement here should have been enforced, either under Delaware law, as the parties agreed, or even under California law, if the court determined it should instead apply. However, the Delaware court declined to enforce the covenant against Mr. Underwood in Ascension. Why?
In addition to the purchase agreement and employment agreement, about six months after the deal closed, the parties entered into a supplemental transaction, and Mr. Underwood signed another – his third – noncompete agreement. It was this third non-compete the Delaware company was attempting to enforce in Ascension. And although the first two non-competes fit nicely into California’s carve out for sale of business assets and goodwill, the third non-compete did not. Specifically, this second deal, even though it was contemplated at the time the original deal was structured, did not involve Mr. Underwood’s sale of any assets or goodwill (he had sold all of his interests in the first round of the deal). Because this third non-compete was not negotiated contemporaneously with an asset or goodwill purchase, the Delaware court concluded that the California carve-out could not save it. The Court’s ruling is particularly interesting given the Third Circuit’s decision in 2011 to enforce a non-compete under a Delaware choice of law provision even though the home-state’s policy in that case (which was Louisiana), like California’s, disfavored non-competes.
The take-away here is that although a Delaware choice of law provision can be appropriate in corporate transactions (and other contexts), it is not an ironclad solution to non-compete challenges. Ascension shows that Delaware courts might not be willing to overlook the fundamental policy of another state even when parties agree to have Delaware law govern. Thus, when including a non-compete covenant in any transaction, the parties must carefully consider choice of law issues, keeping in mind that policies and statutes vary greatly between states.