Texas Court Refuses to Apply Texas Choice of Law in Non-Compete Fight Involving Texas Bank

A recurrent theme in non-compete litigation is the overriding importance of choice-of-law. The latest example comes to us from the United States District Court for the Southern District of Texas and pits a Texas choice-of-law provision against Oklahoma public policy. Let’s take a look:

Sometime in early 2013, Tulsa, Oklahoma based F&M Bank began talks with Prosperity Bank about a possible merger. Those talks progressed into the summer of 2013 and the parties ultimately reached a deal. In August 2013, as part of the merger, Prosperity offered employment agreements to 35, mostly higher level F&M employees. These employees included the plaintiffs in the instant case: Chris Cardoni, Wesley Webb, all of whom worked in Tulsa, Oklahoma. In late August, several of these employees – including the plaintiffs – signed employment agreements (“the Agreements”) with Prosperity. The Agreements were similar in all respects except for compensation. All of the Agreements included non-compete and non-disclosure provisions in exchange for a three-year employment term, access to confidential information, restricted stock and – in one instance – a signing bonus. The merger between F&M and Prosperity took effect on April 1, 2014.

As often happens in mergers, the employees who formerly worked for F&M were unhappy in their new jobs at Prosperity. The employees felt they had been misled about the nature of Prosperity’s business, the nature of their opportunity with the company, corporate policies and employee benefits. Further, the employees maintained that they were misled about their new employment agreements. According to the employees, the former president of F&M Bank and now current president of Prosperity’s Tulsa division told the employees that they would lose their jobs and bonuses if they did not sign the Agreements. Additionally, the employees claimed there was other inequitable conduct related to the Agreements: Some employees allegedly were told not to worry about the Agreements because they would be unenforceable under Oklahoma law. In light of this representation, one employee specifically asked to have a choice-of-law clause changed from Texas law to Oklahoma law. He was told that the Agreement was non-negotiable. But ultimately, the employees signed the Agreements.

By the summer of 2014, things had reached a breaking point. On June 2, 2014, while still employed by Prosperity, the employees filed a lawsuit against Prosperity and certain F&M officers in Oklahoma state court. The Oklahoma state court action sought a declaration that the Agreements were void and unenforceable and also included claims for tortious interference and fraud. Two days later, Prosperity filed a state court action in Texas seeking a declaration that the Agreements were enforceable and asserting claims for breach of contract against the employees. Both cases subsequently were removed to federal court. Once in federal court, Prosperity moved to transfer the Oklahoma case to the Southern District of Texas pursuant to a forum selection clause contained in the Agreements. The Northern District of Oklahoma granted Prosperity’s request and the Oklahoma case was transferred to Texas. Both lawsuits were then consolidated in the Southern District of Texas as of August 5, 2014.

Strangely, all the while, the employees were still working for Prosperity in Tulsa. But ultimately, the employees gave notice of their intent to terminate the Agreements and resign from Prosperity. The employment Agreements were terminated effective August 28, 2014. Four days later, the employees began work at CrossFirst Bank, also in Tulsa, Oklahoma. Meanwhile, the litigation continued in Texas.

Now here is where things get interesting: The parties filed dueling motions on choice of law. Although the Agreements contained a Texas choice of law provision, the employees argued that Oklahoma law should apply. Prosperity et al argued that the Court should honor the contractual choice of law provision and apply Texas law. As practitioners in this space know, Oklahoma non-compete law is much more pro-employee than Texas non-compete law.

I have seen many cases where courts give short shrift to the choice-of-law issue. Based on the facts of this dispute, I would have expected the Court to apply Texas law. After all, Prosperity – the defendant and counter-plaintiff – is based in Houston. And the Agreements say Texas law applies. I have seen a number of cases where courts upheld contractual choice-of-law provisions on similar facts. But that’s not what happened here.

Remember Your Conflicts of Law

A federal court sitting in diversity applies the choice-of-law rules of the forum state.  In this instance, that would be Texas. [Footnote 1]. Texas determines enforceability of contractual choice-of-law provisions under the Restatement (Second) Conflicts of Laws § 187. Section 187 provides, in relevant part that the law chosen by the parties will govern unless either:

a. the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties’ choice, or

b. application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which, under the rule of § 188, would be the state of the applicable law in the absence of an effective choice of law by the parties.

The upshot of all this: 187(2)(a) does not apply because Texas – where prosperity is based – has a substantial relationship to the parties and the transaction. This means choice of law is governed by 187(2)(b). Under that section, the Parties’ choice of Texas law applies unless (1) another state has a more significant relationship to the transaction than Texas (2) that state has a materially greater interest than Texas and (3) that state’s fundamental public policy would be contravened by application of the chosen law.
In evaluating the first prong of the test, the Court weighs a number of factors to determine which state has a more significant interest. Those factors include both specific contacts (e.g. the domicile of the parties, place of incorporation, place of contracting, etc.) and more abstract policy considerations like the needs of interstate systems, the polices of the interested states, and the parties’ expectations. In the instant case, all of the employees were Oklahoma residents, negotiated their contracts in Oklahoma and worked in Oklahoma. Now, Prosperity was seeking to prevent them from working in Oklahoma. On the flip side, Prosperity was a Texas company, the place of contract was Texas and the Agreements indicated Texas law would apply (which goes to the parties’ expectations). Ultimately, the Court concluded that Oklahoma had a greater interest in the transaction. In reaching this conclusion, the Court emphasized that the employees worked only in Oklahoma. The Court noted that this factor alone can be dispositive in choice of law analysis. [Footnote 2]. So the first prong of the test is satisfied.

Next, the Court considered whether Oklahoma had a materially greater interest than Texas in determining the enforceability of the restrictive covenants at issue. Texas has an interest in enforcing contracts entered by Texas citizens and Texas companies. On the flip side, Oklahoma has an interest in determining whether or not a non-compete agreement can bar Oklahoma residents from working for an Oklahoma bank in Oklahoma. While noting that Texas did have an important interest at stake, the Court concluded that Oklahoma’s interest was greater because the matter ultimately involved restrictions on the conduct of Oklahoma citizens within the borders of Oklahoma.

Finally, the Court addressed the public policy factor. The ultimate question here is whether applying Texas non-compete law contravenes a substantial or fundamental Oklahoma public policy. Many states, including Oklahoma, consider restraints of trade and enforcement of non-compete agreements matters of fundamental state policy. And as it turns out, from a comparative law perspective, Oklahoma takes a far more restrictive view of non-compete agreements than Texas.  Under Oklahoma law, a non-compete agreement that generally prohibits an employee from engaging in his profession is unenforceable. Further, Oklahoma law allows for relatively limited reformation of overbroad non-compete agreements, whereas Texas law requires judicial modification to make such agreements reasonable. The bottom line: Application of Texas law to the instant dispute would contravene fundamental Oklahoma public policy. As a result, Oklahoma law controls the non-compete and non-solicitation claims, while Texas law applies to the non-disclosure claims (because non-disclosure agreements to not run afoul of Oklahoma policy).  The employees also brought a fraud claim against Prosperity and various corporate officers. After conducting a choice of law analysis, the Court determined that Oklahoma law would apply to this claim as well.

After resolving the choice-of-law issue, the Court finally reached the merits of the dispute: The enforceability of the Agreements at issue and cross-motions for summary judgment. Under Oklahoma law, non-compete agreements are void unless they fall into certain narrow statutory exceptions. The relevant exceptions for this case relate to (1) the sale of goodwill in a business and (2) certain narrow post-employment restrictions. As to (1), Prosperity argued that because the employees received stock in the company, the non-compete agreements were reasonable and enforceable as restraints attendant to the sale of goodwill in a business. The Court found that the employees’ stock interest was not appreciable enough to justify application of the goodwill exception. This left only the narrow post-employment exception. Under Oklahoma law,

A person who makes an agreement with an employer, whether in writing or verbally, not to compete with the employer after the employment relationship has been terminated, shall be permitted to engage in the same business as that conducted by the former employer or in a similar business as that conducted by the former employer as long as the former employee does not directly solicit the sale of goods, services or a combination of goods and services from the established customers of the former employer.

Okla. Stat. Ann. tit. 15, § 219A (West).  The Agreements in instant case went far beyond this. In terms of geographic scope, the Agreements restricted competition within a 50-mile radius of any F&M or Prosperity Bank. This effectively covers all of Oklahoma and Texas. In short, the employees were prohibited from working in banking, period, anywhere in Oklahoma or Texas for three years. In fact, the employees were also prohibited from working for any Prosperity competitor even if they did so in an entirely different job capacity. The Agreement also contained aggressive restrictions barring the employees from having any contact with Prosperity customers and prospective customers. And finally, the Agreements prohibited the employees from having any contact with Prosperity’s current employees.

The bottom line: The restrictive covenants at issue go far beyond what Oklahoma law allows. The Court entered summary judgment for the employees holding that the non-compete and non-solicitation provisions in the Agreements were unenforceable. The other claims – Prosperity’s claims for breach of the non-disclosure provision and the employees’ claims for fraud – will move forward.

The Takeaways

(1) Choice of Law Matters:  Non-compete agreements are governed by state law. There is tremendous variation in non-compete law from one state to the next. This case gives us a great example: The non-compete and non-solicitation provisions would have been enforceable under Texas law. They are completely unenforceable under Oklahoma law. If you throw different state laws into the mix, the results can change dramatically.

(2) Consider Fighting the Choice of Law Fight:  In this case, you had a Texas corporation seeking to enforce a Texas choice-of-law provision in a Texas court. There are numerous cases where courts have upheld contractual choice of law provisions on similar facts. Here’s an example: a case from Missouri that I wrote about last year. I could easily see a court saying that Texas has an interest in protecting its corporate citizen Prosperity, protecting Prosperity’s reasonable expectations and enforcing its contracts—and that this interest trumps. Apparently, Prosperity assumed Texas law would apply because it also moved for a preliminary injunction and briefed the issues under Texas law. Although I would have expected the Court to apply Texas law, I feel that the Court’s analysis – and ultimate application of Oklahoma law – is the correct outcome. Bottom line:  It’s worthwhile to explore the choice of law argument and do the analysis.  If there’s even a small chance of winning the choice of law fight, then take your shot.

The case is Cardoni v. Prosperity Bank, 2014 WL 4982600 (S.D. Tex. Oct. 6, 2014).

Footnotes:

[1] I note, however, that this general principle does have an exception: Where a case is transferred from one federal court to another under 28 U.S.C. 1404, the receiving or transferee court is required to follow the choice-of-law rules of the transferor court. Here, the employees initiated their action in Oklahoma and that action was transferred to the Southern District of Texas under 1404. The Texas court consolidated two actions: the case originally filed in Oklahoma and the case originally filed in Texas. To get technical, Oklahoma choice-of-law principles should have been applied to the part of the action that was transferred in from Oklahoma. But the end result would have been exactly the same: Oklahoma applies the doctrine of lex loci contractus when faced with a contract claim and a choice of law dispute. The law of the state where the contract is made controls. A contract is made wherever the last action necessary for the formation of the contract takes place. In the instant case, the employees signed the contracts in Oklahoma and returned them to Prosperity who then executed them in Texas. As such, the place of contracting was Texas. So under Oklahoma choice of law rules, Texas law presumptively would apply. BUT, in this specific instance, an Oklahoma court would have gone a step further and said that application of Texas law violated Oklahoma public policy regarding restraints of trade. So, in the end, under Oklahoma choice of law rules, Oklahoma law would have applied.

[2] This is an incredibly important point to note: Where there is an agreement related to the performance of personal services in a particular state, that factor alone can be dispositive in establishing that the law of that state controls. The seminal Texas case – cited by the Court – is DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 679 (Tex. 1990), which collects cases from a number of other jurisdictions on this point.

Jonathan Pollard is a trial lawyer and litigator based on Fort Lauderdale, Florida. He focuses his practice on defending non-compete and trade secret claims. Jonathan routinely represents doctors, corporate executives and other high level employees who are switching companies, or, who have started their own ventures. Beyond litigation, Jonathan advises employees, companies and business owners regarding restrictive covenant issues in connection with employment contracts, separation agreements, hiring decisions, the purchase or sale of business interests and the execution of commercial leases. Jonathan has been interviewed about non-compete issues by reporters from INC Magazine, the BBC, the National Federation of Independent Business and The Tampa Bay Times. In addition to his background in non-compete and trade secrets work, Jonathan has broad experience as a competition lawyer, generally, and has litigated numerous cases under both the Sherman and Lanham Acts. He is licensed in all Florida federal and state courts and routinely represents clients in Miami, Fort Lauderdale, West Palm Beach, Fort Myers, Tampa, Orlando and Jacksonville. His office can be reached at 954-332-2380. For more information, visit http://www.pollardllc.com.