Choice of Law Issues in Non-Compete Agreements
April 1, 2008
© Copyright 2008. All rights reserved. I. CHOICE OF LAW ISSUES IN NON-COMPETE AGREEMENTS
The State of Georgia has a strict public policy against restraints on trade, which has resulted in "employee restriction" contracts in Georgia being subject to strict scrutiny. Where a non-compete covenant in the employment context creates a restraint on trade, it is against Georgia public policy and therefore unenforceable.1
Georgia's public policy against restraints on trade has resulted in many non-compete covenants being construed under Georgia law, despite the parties' intention to apply the law of another state. Hulcher Services, Inc. v. R.J. Corman Railroad Co., LLC, 247 Ga. App. 486, 543 S.E.2d 461 (2000)(Applying Georgia law over Texas law) See also, Nasco, Inc. v. Gimbert, 239 Ga. 675, 238 S.E.2d 368 (1977) (Applying Georgia law over Tennessee law); Enron Capital & Trade Resources Corp. v. Pokalsky, 227 Ga. App. 727, 490 S.E.2d 136 (1997) (Applying Georgia law over Texas law); Barnes Group, Inc. v. Harper, 653 F.2d 175, 178 (5th Cir., Unit B 1981), cert. denied, 455 U.S. 921 (1982) (Applying Georgia law over Ohio law); Marketing and Research Counselors, Inc. v. Booth, 601 F.Supp. 615, 616 (N.D. Ga. 1985) (Applying Georgia law over Texas law).
Because Georgia has not adopted the Restatement (Second) § 187(2), Georgia courts need not determine whether Georgia has a "materially greater interest" in applying Georgia law, as opposed to the law of another state, before invalidating a non-compete provision as against Georgia public policy. Convergys Corp. v. Keener, 276 Ga. 808, 582 S.E.2d 84 (2003). A party must only have at sufficient contacts with the State of Georgia to justify application of Georgia law. Applying this rule, the Eleventh Circuit in Keener v. Convergys Corporation, 342 F.3d 1264, 1268 (11th Cir. 2003) applied Georgia law to the non-compete at issue, despite a provision providing that Ohio law would govern.
As a practical matter, Georgia's application of its own law contrary to the laws of other states on public policy grounds could potentially allow employees to move to Georgia and file a preemptive lawsuit solely to avoid their non-compete agreements. It also raises the issue of how broad Georgia court may impose injunctive relief. In Keener, for example, the court limited injunctive relief to the State of Georgia. In doing so, while the court found that Georgia's public policy could override the policies of other states, it impliedly recognized that it could not impose its public policy on other states.
By contrast, in Hostetler v. Answerthink, Inc., 267 Ga. App. 325, 599 S.E.2d 271 (2004), the injunctive relief was not limited to Georgia; however, this case had markedly different facts, in that the non-compete agreement was executed in Georgia, by a Georgia resident who would be working in Georgia.
The Eleventh Circuit's decision in Palmer & Cay, Inc. v. March & McLennan Companies, 404 F.3d 1297 (11th Cir. 2005), could be read to sanction the preemptive lawsuits mentioned above. In Palmer & Cay, Meathe was a managing director for Marsh. In January 2003, Meathe left Marsh and became president of Palmer & Cay, an insurance broker which was a competitor of Marsh. Meathe moved to Georgia and filed suit in the Northern District of Georgia seeking to avoid application of his non-compete agreements with Marsh. The non compete agreements at issue contained choice-of-law provisions providing that New York and Illinois law would apply. The court applied Georgia law and held that the agreements were unenforceable under Georgia law. In fashioning relief, relying on Hostetler, the court ultimately held that while injunctive relief should be limited to Georgia, declaratory relief should not be so limited. Thus, Meathe was able to move to Georgia, file a preemptive lawsuit, and avoid application of his restrictive covenants. In effect, this decision may be read to allow Georgia's policy of refusing to enforce non-compete agreements which may be enforceable under other state's laws to potentially override the policies of other states with more significant contacts, where the employee moves to Georgia for the purpose of filing suit here. Under a broad reading of Palmer & Cay, an employee working in another state, who signs a non-compete agreement which is enforceable under the laws of that state and which contains a choice-of-law provision providing that the other state's law applies, could potentially avoid the non-compete agreement by moving to Georgia and filing suit.
Importantly, only a final judgment, not temporary injunctive relief, has preclusive effect in other jurisdictions. In Hulcher, 543 S.E.2d 461 (Ga. App. 2001), the plaintiff filed suit in Georgia, seeking a declaration that the non-compete at issue was unenforceable. Thereafter, the defendant filed suit in Texas, and obtained preliminary injunctive relief enforcing the covenant. Id. at 487. After the Georgia court entered a final judgment declaring the covenant unenforceable, the defendant appealed, claiming that the final judgment of the Georgia court should be vacated due to the interlocutory injunction entered by the Texas court. The Georgia Court of Appeals disagreed, holding that "only a final adjudication on the merits precludes [another], separate jurisdiction fro making a determination on the merits." A final judgment as to enforceability by a Georgia court precludes re-litigation of these issues in other jurisdictions. Id.; See also, Hostetler v. Answerthink, Inc., 267 Ga. App. 325, 599 S.E.2d 271 (2004).
In order to avoid the preemptive lawsuits mentioned above, employers can take some actions, including drafting non-compete agreements to be enforceable under the laws of the State of Georgia. As recently recognized in Smallbizpros, Inc. v. Court, 414 F.Supp.2d 1245, 1249 (M.D. Ga. 2006), where the other state's law does not contravene the public policy of the State of Georgia, it will be applied. The court in Smallbizpros applied Michigan law to a covenant not to compete related to territorial restrictions, finding that under either Michigan or Georgia law, the covenant at issue was enforceable. Accordingly, application of Michigan law did not violate Georgia public policy.
1. Forum Selection Clauses.
Contrary to choice of law provisions, Georgia courts have consistently enforced mandatory and exclusive forum selection clauses in employment agreements. Iero v. Mohawk Finishing Products, Inc., 243 Ga. App. 670, 534 S.E.2d 136 (2000). Courts have found that these clauses involve procedural, rather than substantive, rights. Lease Finance Group v. Delphi, Inc., 596 S.E.2d 691 (Ga. App. 2004).
In Iero, where the employee failed to show that enforcement of the forum selection clause was unreasonable under the circumstances of the case, the court enforced the clause. See also, OFC Capital v. Colonial Distributors, Inc., 648 S.E.2d 140 (Ga. App. 2007) (stating that a freely negotiated forum selection clause "should be upheld absent a compelling reason such as fraud, undue influence, or overweening bargaining power."); Lease Fin. Group v. Delphi, Inc., 596 S.E.2d 116 (Ga. App. 2004)("[v]enue forum selection clauses are prima facie valid and should be enforced unless enforcement is shown by the resisting party to be unreasonable under the circumstances."); Carter's Royal Dispos-All v. Caterpillar Financial Services, 609 S.E.2d 116 (Ga. App. 2004)(to invalidate forum selection clause, opposing party must show that "trial in the chosen forum will be so inconvenient that he will, for all practical purposes, be deprived of his day in court."); SE Business Services, Inc. v. Bryant, 600 S.E.2d 610 (Ga. App. 2004).
It is important to note the difference not only between a forum selection clause and a choice of law provision, but also between a forum selection clause and a consent to jurisdiction clause. In Georgia, consent to jurisdiction clauses, like forum selection clauses, are prima facie valid and should be enforced unless enforcement is shown by the parties to be unreasonable under the circumstances. Lease Finance Group, 596 S.E.2d at 692. However, Georgia courts have recognized an important distinction between these two types of provisions. While forum selection clauses dictate where a suit must be filed, consent to jurisdiction clauses provide only that the parties have consented to jurisdiction in the event that a suit is filed in a particular forum. Murray v. The Education Resources Institute, Inc., 612 S.E.2d 23 (Ga. App. 2005)(citing Carbo v. Colonial Pacific Leasing Corp., 592 S.E.2d 445 (Ga. App. 2003)). In other words, a consent to jurisdiction clause does not mandate that suit be brought in a particular court. Rather, it simply provides that the parties have consented to jurisdiction in a certain forum, allowing a suit to be brought in a place where jurisdiction and venue might otherwise not be proper. Id.
II. ARBITRATION CLAUSES IN EMPLOYMENT CONTRACTS.
The Georgia Arbitration Code (GAC) governs arbitration proceedings in Georgia, to the extent they are not preempted by the Federal Arbitration Act. See, O.C.G.A. §§ 9-9-1, et. seq. The GAC applies to all disputes in which the parties have agreed in writing to arbitrate, and provides the exclusive means by which such agreements can be enforced. See, O.C.G.A. § 9-9-2. It provides a means by which the parties can demand arbitration, procedures to be followed in arbitration, discovery rules, selection of an arbitrator, the effect of an award, and procedures for appealing or vacating an award. Id.
The GAC does not apply to "any contract relating to terms and conditions of employment unless the clause agreeing to arbitrate is initialed by all signatories at the time of the execution of the agreement." O.C.G.A. § 9-9-1(c)(9)(Emphasis supplied). Thus, under Georgia law, unless the parties must initial an arbitration clause contained within an employment contract, it is unenforceable. See, e.g., ISS Int'l Serv. Sys. v. Widmer, S.E.2d 820 (Ga. App. 2003); Primerica Financial Services, Inc. v. Wise, 217 Ga. App. 36, 456 S.E.2d 631, 635 (1995); Columbus Anaesthesia Group, P.C. v. Kutzner, 218 Ga. App. 51, 459 S.E.2d 422 (1995).
1. Preemption By The Federal Arbitration Act.
Where an arbitration agreement falls within the scope of the Federal Arbitration Act (FAA), the federal statute preempts the GAC. Attenborough v. Dillard's Dep't Store, 2006 U.S. Dist. LEXIS 42897 (N.D. Ga. 2006); Columbus Anaesthesia Group, 459 S.E.2d at 423. A contract falls within the scope of the FAA where it "evidenc[es] a transaction involving commerce." 9 U.S.C. § 2. See, Caley v. Gulfstream Aero. Corp., 428 F.3d 1359 (11th Cir. 2005); Greenway Capital Corp. v. Schneider, 229 Ga. App. 485, 494 S.E.2d 287 (1997)("Where there has been no agreement by the parties to be bound by state arbitration law, and where the transaction involved interstate commerce within the meaning of the [FAA], state law is preempted by federal law"); Hydrick v. Management Recruiters International, Inc., 738 F.Supp. 1434 (N.D. Ga. 1990)(where contract involved interstate commerce, FAA governed over state arbitration law).
Federal law will not preempt state law where there is no effect on interstate commerce. In Columbus Anesthesia Group, the court held that the GAC applied to a doctor's employment agreement, where it did not involve interstate commerce because it was for membership in a Georgia corporation and for services to be performed in Georgia. Id. at 424.
Under the FAA, the agreement to arbitrate must be in writing, but it does not have to be executed by the parties. Caley v. Gulfstream Aero. Corp., 428 F.3d 1359, 1368-69 (11th Cir. 2005); Nguyen v. Federated Dep't Stores, Inc., 2005 U.S. Dist. LEXIS 39642, * 7 (N.D. Ga. 2005).
Section 1 of the FAA contains a narrow exemption. Under Section 1, employment contracts of transportation workers are exempt, even where interstate commerce is involved. Circuit City Stores v. Adams, 121 S.Ct. 1302, 522 U.S. 105 (2001)(construing exemption in Section 1 of the FAA which states: "[N]othing herein contained shall apply to contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce." 9 U.S.C.A. § 1); See, Attenborough, 2006 U.S. Dist. LEXIS 42897 at * (FAA applies where employee was not a transportation worker); Hill v. Rent-A-Center, Inc., 398 F.3d 1286 (11th Cir. 2005)(where employee not a transportation worker, arbitration agreement is not exempt from the FAA); Roberson v. Clear Channel Broadcasting, Inc., 144 F.Supp.2d 1371 (S.D. Fla. 2001).
Parties to a contract also have the ability to agree whether federal or state arbitration law will control the arbitration. In Primerica, 456 S.E.2d at 635, the court held that the GAC did not apply, because the parties had expressly agreed within the contract that the FAA would govern arbitration.
2. Claims Subject To Arbitration.
The claims that are subject to arbitration depend upon the scope of the parties' agreement. TermNet Merch. Servs. v. Phillips, 277 Ga. 342, 588 S.E.2d 745 (2003) (bifurcating trial of the case, holding that all claims arising from the employment be submitted to binding arbitration as provided in the agreement); BellSouth Corp. v. Forsee, 265 Ga. App. 589, 595 S.E.2d 99 (2004) (arbitration provision required arbitration of "any dispute, controversy or claim arising out of or relating to" the employment agreement or to "the breach, termination or invalidity" thereof, pursuant to the rules of the American Arbitration Association.") All doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration. Forsee, 595 S.E.2d at 102-03. An injunction against arbitration is only warranted where a claim "clearly falls outside of the substantive scope of the agreement." Id. In deciding whether a claim is subject to arbitration, the court should not examine the merits of the claims. Id.
3. Authority Of Courts To Restrict Competition Pending The Outcome Of Arbitration.
Where a valid arbitration clause exists in an employment agreement, pursuant to Section 3 of the FAA (See, 9 U.S.C. § 3), courts have the authority to stay a pending litigation pending the outcome of the arbitration. Jones v. Titlemax of Ga., Inc., 2006 U.S. Dist. LEXIS 11706 (N.D. Ga. 2006)(although court held that all of plaintiffs' claims were subject to arbitration, it stayed the litigation, rather than dismiss it, in the event that the arbitrator concluded that any of plaintiffs' claims belong in court.) The court also has the authority to grant a temporary injunction restricting competition while arbitration is pending, so long as the non-compete agreement is enforceable. In Forsee, 595 S.E.2d at 100, the trial court originally granted an ex parte TRO enjoining Forsee from accepting employment with Sprint pending arbitration. After conducting an emergency hearing, the court issued an order finding the non-competition covenant in Forsee's employment agreement to be unenforceable under Georgia law and dissolved the part of the TRO that related to it. BellSouth appealed, arguing that the court erroneously made a determination on the issue of enforceability, which should have been left to the arbitrator. The Georgia Court of Appeals affirmed, holding that the severability clause in the contract allowed the trial court to modify the TRO and to remove the issue of enforceability from the arbitrator's decision.
In Merrill Lynch, Pierce, Fenner, & Smith v. Schwartz, 991 F.Supp. 1480, 1482 (M.D.Ga. 1998), the court granted an injunction pending the outcome of arbitration before the National Association of Securities Dealers (NASD) After finding the covenant not to compete valid, the court reasoned that even a few days of solicitation can cause irreparable harm in this case, and an injunction was warranted. Id. at 1482.
4. Review of Arbitrator's Award.
Under Georgia law, judicial review of an arbitrator's award is very narrow. Malice v. Coloplast Corp., 629 S.E.2d 95 (Ga. App. 2006)("judicial review of an arbitration awards is among the narrowest known to the law"). Courts are not permitted to inquire into the merits of the case or consider the sufficiency of the evidence. Lanier Worldwide, Inc. v. BridgeCenters at Park Meadows, LCC, 633 S.E.2d 49 (Ga. App. 2006). Arbitrators are permitted to make an award on broad principles of fairness and equity and need not state the basis to support their award. With respect to modification of an arbitration award, the scope of a trial court's review is governed by statutory grounds. Id.
The FAA provides four grounds upon which a court may vacate an arbitrator's award. See, 9 U.S.C. § 10. In addition, Georgia has recognized three additional bases on which an award may be vacated: (1) if the award is arbitrary and capricious; (2) if it is contrary to public policy; or (3) if it is made in manifest disregard of law. Malice, 629 S.E.2d at 98. A decision is only in "manifest disregard" of the law if the arbitrator deliberately ignored the law. An error in interpretation of the law will not constitute manifest disregard. Id. In Malice, the employee challenged the arbitrator's decision that he had violated his non-compete agreement, arguing that it was in manifest disregard of the law. The court upheld the award, finding that the employee was merely asserting that the arbitrator erred in interpreting the law. The court agreed with the arbitrator's finding that the covenants at issue were enforceable and that the employee violated them.
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