TheCorporateCounsel.net

Nearly 2 million companies are incorporated in Delaware, and many of them employ “choice of law” and “exclusive forum” provisions to give themselves the benefit of the state’s specialized expertise in matters of corporate governance. Apparently, though, companies these days are liking Delaware a little too much. In response to a growing number of lawsuits that call on the Court of Chancery to rule on matters outside the scope of its mission – specifically, trying to shoehorn employment disputes into matters of internal affairs – Vice Chancellor Laster leads off this 68-page opinion with a plea to make it stop.

The dispute here related to whether incentive compensation awards were forfeited upon breach of a contractual restrictive covenant included in an LLC agreement. The various individuals and entities were scattered across 4 states (none of them being Delaware). VC Laster said it’s not the first time he’s seen this approach:

But Sunder filed suit here—in Delaware—because Sunder is a Delaware LLC and its lawyers deployed the now widespread legal technology of inserting restrictive covenants into an internal governance document. Businesses and their lawyers do that so they can invoke Delaware’s contractarian regime and argue that it should override how other jurisdictions regulate restrictive covenants.

That legal technology calls on the Delaware courts to adjudicate postemployment disputes for the country and potentially the world. In the past five years alone, the Court of Chancery has issued written decisions addressing disputes over restrictive covenants for businesses operating in Hong Kong, Italy, Alabama, Arizona,4 California, Colorado, Idaho, Illinois, Louisiana, Nebraska, New Jersey, New York, Oklahoma, and Texas. Only two businesses operated in Delaware, one of which filed two cases. That list excludes transcript rulings.

The Chancellor expresses several concerns with this trend, including: it will undermine the deference that other states accord to Delaware law, it’s unsustainable from a resource perspective, and it diverts the court’s attention from its core mission. VC Laster then notes that there are times when Delaware won’t enforce a choice of law provision:

This is an example of drafters attempting to use Delaware law to set the rules for what are effectively employment relationships. Other jurisdictions often have a more significant interest in regulating those relationships, which affect how their citizens living there can earn a living and how a business operating there can compensate its work force.

Delaware follows the Restatement (Second) of Conflict of Laws, and Delaware courts consequently will not enforce choice of law provisions when doing so would circumvent the public policy of another state that has a greater interest in the subject matter.

Consequently, when a different state’s law would govern in the absence of a choice of law provision, and if that state has established legal rules reflecting a different policy toward restrictive covenants than Delaware’s, then this court will defer to that state’s law notwithstanding the presence of a Delaware choice of law provision.

Applying that formula, VC Laster couldn’t toss this case. Here is his scream into the void:

A solution needs to be found, and the market is unlikely to provide it. This is an area where Delaware’s interests and the interests of its bar as a whole conflict with the individual interests of clients and their lawyers. For any single business, it makes sense for a lawyer to advise the client to embed restrictive covenants in an internal governance document. And for any single business faced with a dispute over those restrictions, it makes sense for a lawyer to advise the client to file a lawsuit in the Court of Chancery. In the aggregate, that is a recipe for a tragedy of the commons.

A judicial solution is also unlikely, because judges decide specific cases. Doubtless there are many combinations of fixes involving choice of law, personal jurisdiction, and subject matter jurisdiction that could address this burgeoning problem. But a cure requires the involvement of policymakers beyond the courts.

In an ideal world, this case would have been filed in Utah, Nevada, or Texas. But the case is here, and it must be decided.

He’s right that things are unlikely to change. Delaware is just too good.

– Liz Dunshee