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More on California Non-Competes – But This Time from Delaware

When it comes to California non-competes, you can never get enough clarity.  And when that clarity comes from a Delaware Chancery Court, it adds a utility element that our corporate brethren appreciate.

Ascension Insurance Holdings, LLC v. Underwood involved a pretty straightforward scenario: a Delaware limited liability company purchased certain assets and goodwill from an insurance company partially owned by Robert Underwood – a California resident.  Even though the LLC did business exclusively in California, the transaction documents called for the choice of Delaware law.  Given that Delaware enforces choice of law clauses and California permits non-competes when someone sells their equity interests, game over, right?

Not so, at least not under the circumstances of this case.  Yes, it is true that Delaware courts will generally give effect to choice of law provisions. But the Delaware litigant in this case ran into the buzz-saw of the California non-compete law, which only enforces non-competes against sellers of business goodwill.  So unless this particular provision passed Golden State muster, the Delaware court was not going to permit a private party to (purport to) trump a sister state’s fundamental public policy.

As it turns out, the non-compete provision in the asset agreement was indeed fully enforceable under California law because Mr. Underwood sold his entire equity interest, including his goodwill.  But the purchaser was trying to enforce an extension of Mr. Underwood’s original non-compete – an extension that was included in another set of investment documents that Mr. Underwood signed six months after the original deal closed.  The court found that the purchaser could not revive the original non-compete in the later documents because they were not contemporaneous with his sale of his equity – even if the parties had discussed the later investment at the time the initial transaction closed.  Because the non-contemporaneous “extension” did not qualify as an exception to California’s non-compete ban, it was not enforceable.

So the morals of the case are these: the filing of a case in a Delaware Chancery Court by a Delaware domiciliary on a contract with a Delaware choice of law provision all have a Delaware forum in common. But when a litigant in that Delaware forum asks the court to disregard the fundamental public policy of a sister state, the court won’t do it.  And if a party is looking to bind a California resident to a non-compete provision in a sale of business context, make sure those provisions are included in the deal documents – before the deal is closed.

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Jennifer B. Rubin is a Mintz Member who advises clients on employment issues like wage and hour compliance. Her clients range from start-ups to Fortune 50 companies and business executives in the technology, financial services, publishing, professional services, and health care industries.