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When is business restriction “so repugnant” it excludes choice of Delaware law?

On Behalf of | Aug 8, 2022 | Corporate Litigation

The choice of Delaware law is often favorable for certain business matters, like do not compete covenants and other limitations on business transactions. Businesses will often take advantage of these benefits by having their agreements drafted to apply Delaware law in the event of a dispute.

Although Delaware courts generally uphold these agreements, there are instances when they find the matter “so repugnant to the law of the state” that it will refuse to honor the terms of the contract.

Recent case challenges choice of law

In a recent case from the Court of Chancery for the State of Delaware, two brothers sold a family business to a private investment firm and two Delaware limited liability companies — both of which are in the same home state as the plaintiffs. The agreements included restrictive covenants, but the brothers argue the covenants are not applicable because they go against public policy in their state. The applicability of the covenants in this case comes down to a question of law: does the home state’s law, in this case Oklahoma, apply or is the matter resolved using the agreed upon governing law in the contract, Delaware law.

The defendants point out that a number of documents related to the sale name Delaware as the governing law. These include a Noncompetition, Nonsolicitation, Noninterference, and Confidentiality Agreement as well as the Operating Agreement of one of the buyers. The plaintiffs point out that employment agreements name Oklahoma as governing law.

Upon review, the court notes that to come to its decision it must first determine if there is a conflict between the two states’ laws. If there is not a conflict, the court will generally move forward with Delaware law. If there is a conflict, the courts use the Restatement (Second) of Conflict of Laws Section 187 to decide which state’s law to apply. The other state may win if it has a “materially greater interest” in the issue.

In this case, there is a conflict over the restrictive covenants. The court needs to use two tests to determine which state’s law applies. The first is the “most significant relationship” test. Then the court moves on to a context specific application as it applies to contracts through Section 188 of the restatement. Both contain several factors for court analysis. Upon review of these factors and the facts of this case, the court finds that there is no conflict when it comes to the solicitation agreement, but that there is conflict for the other covenants. It ultimately decides that the majority of factors, including the intent of the parties when entering the contract, weigh in favor of application of Delaware law.

What can other businesses learn from this case?

Important lessons from this case include:

  • The ruling can be a mix of state laws. The court notes that it is not bound to decide all issues under a single state’s laws. Thus, it is possible that in this type of situation each provision could apply a different state law.
  • The decision is fact intensive. The courts generally apply the facts of the case to a number of different factors before coming up with their determination.

These cases are complex matters of law and as noted above it is possible for the court to decide the issue runs too afoul of the home state’s law to allow the application of Delaware law. As such, it is generally wise to seek counsel experienced in the workings of the Delaware Court of Chancery.