On the Efficacy of Litigating Post-Employment Disputes in Delaware (Reciprocity Is a Two-Way Street)

Last November, Vice Chancellor J. Travis Laster issued an Opinion in Sunder Energy, LLC v. Jackson denying a company’s application for a preliminary injunction against a former employee based on restrictive covenants embedded in that employee’s Incentive Units. The Court held that the company could not enforce the covenants because the company’s Managers breached their fiduciary duties in the creation of those covenants, and because the covenants themselves are “overly broad” and “unreasonable.” The Court noted, for example, that covenants in this residential solar panel sales company’s Incentive Units could theoretically have indefinitely prevented the former employee’s daughter from door-to-door sales of Girl Scout cookies.

The decision pertained to Plaintiff Sunder Energy, LLC (“Sunder”), a Utah-headquartered Delaware LLC with an almost nationwide footprint. Its former employee, Tyler Jackson, is a Texas resident. Though the Court recognized that this employment relationship is not “quintessentially [an] internal dimension of an entity’s affairs,” the Delaware “hook” for jurisdiction in this case is what the Court describes as the “widespread legal technology of inserting restrictive covenants into [] internal governance document[s].”

The Delaware Court of Chancery is the premier business court in the world, and is no stranger to adjudicating disputes for companies based outside of Delaware. There are nearly two million entities chartered in Delaware (according to Del. Div. of Corps., 2017 and 2022 Annual Reports), and this number likely will continue to grow. The Court described its “core role” as “resolv[ing] internal governance disputes for Delaware entities.” And yet, in only the last five years, the Court has issued decisions addressing post-employment disputes related to restrictive covenants for businesses operating in Hong Kong, Italy, and at least a dozen states.

While Delaware has an obvious interest in governing the internal affairs of Delaware entities, the Vice Chancellor questioned the state’s interest in governing what is essentially a compensation and employment dispute between parties where other states would appear to have a much greater interest. Although the Court noted the potential for these types of cases to overwhelm an already incredibly busy bench—one that was forced to expand from five to seven judges in 2018 to meet growing demand—the even greater issue the Court highlights pertains to comity.

Delaware has an “overriding interest in the interpretation and enforcement of [its] entity laws.” Diedenhopen-Lennartz v. Diedenhofen, 931 A.2d 439, 451–52 (Del. Ch. 2007). The state expects other sovereigns to respect and defer to that interest in order to ensure the Court of Chancery is the court deciding disputes regarding the internal governance of Delaware entities; the same is true of the deference accorded to other jurisdictions’ determinations about entities formed under their laws. In his Opinion, the Vice Chancellor worries aloud that “Delaware risks jeopardizing that deference” if Delaware continues permitting restrictive covenants inserted into internal governance documents “to override the law of other states on issues of great importance to them.” That is why Vice Chancellor Laster calls for “the involvement of policymakers beyond the courts” before accepting jurisdiction, analyzing, and denying Sunder’s application for preliminary injunction.

Sunder is not the first time Vice Chancellor Laster has addressed these potential policy issues. As early as 2020, in Focus Fin. P’rs, LLC v. Holsopple, 241 A.3d 784 (Del. Ch. 2020), Vice Chancellor Laster commented in a footnote:

Delaware’s role as a chartering jurisdiction depends on other states deferring to the application of Delaware law to the internal affairs of entities, the increasing frequency with which parties use Delaware law to create conflicts with the substantive law of other jurisdictions raises significant public policy issues for this state.

Vice Chancellor Laster has also voiced these concern in numerous other decisions and transcript rulings, and he has been cited by multiple law review articles that address similar concerns. More recently, following Sunder, Vice Chancellor Laster has written on the issue in separately published articles. Building on Professor John Coyle’s work researching statutes that invalidate choice of law and choice of forum clauses, the Vice Chancellor proposed amending Section 2707 of Title 6 of the Delaware General Code, which governs agreements not to compete with respect to physicians. Vice Chancellor Laster’s recommendation would, first, void choice of law provisions selecting Delaware law unless the services rendered or business sold are in Delaware; and, second, make explicit Delaware courts’ authority to decline jurisdiction over such disputes except where services are rendered in Delaware or a where a business that operates in Delaware is sold. He reiterated that this recommendation was only a “starting point” and that it was his desire for people to continue thinking about these issues and refining the solutions to them.

Perhaps not surprisingly, in December 2023 Sunder filed a request for certification of an interlocutory appeal concerning the case. That filing cited Vice Chancellor Laster’s policy discussion and separately published articles, and asked that the Delaware Supreme Court “weigh in on the important policy considerations surrounding restrictive covenant cases” because “the Court [] raised a number of policy concerns regarding the desirability of litigating restrictive covenant disputes in the Court of Chancery.” Vice Chancellor Laster certified the appeal on December 22, 2023.

The Supreme Court accepted the interlocutory appeal on January 25, 2024, and the parties agreed to stay the case pending the appeal. Briefing in the Supreme Court is set to be completed mid-April, and this blog will keep readers apprised of any updates on this case, as well as the broader policy issues addressed therein and beyond.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.