Non-Competition Agreements and Arbitration

By Fredrick P. Niemann, Esq. of Hanlon Niemann, a Freehold, NJ Arbitration Attorney

Although the Federal Arbitration Act is federal legislation, that is, the law of the land, the frequency with which it is part of standard employment contracts means that state courts, rather than federal courts, are more frequently called on to apply the Act to a contract dispute. Thirty years ago, the U.S. Supreme Court said that the Act declares “a national policy favoring arbitration.” More recently, it has firmly come down against what it regarded as a state Supreme Court’s “judicial hostility” towards arbitration.

The case arose out of litigation that ensued when two employees, whose contracts with their employer included non-competition and arbitration clauses, left those jobs to work for one of the employer’s competitors. The former employer demanded arbitration, and the former employees countered by suing in state court for an injunction against enforcement of the non-competition clauses. By statute, the state has limited the enforceability of non-competition agreements. When a lower state court ruled that it was for the arbitrator in the first instance, not the court, to decide on the validity of the non-competition clause, the decision was overturned by the state’s Supreme Court, which effectively ordered the state trial court not to defer to any arbitrator on the issue of the validity of the non-competition clause.

The final arbiter—the U.S. Supreme Court—agreed with the lower state court.

When the Supreme Court reversed, deciding in favor of having an arbitrator, not a state or even a federal court, tackle the issue of the non-competition clause, it stressed the “great importance” of state courts’ adhering to a correct interpretation of the Act. It further relied on a “mainstay” of Arbitration Act jurisprudence—that attacks on the validity of a contract, as opposed to attacks only on the validity of a contract’s arbitration clause itself, are to be resolved by the arbitrator. In other words, the working rule is that the arbitration provision is severable from the rest of the contract, so that its validity is for a court to decide but the rest is for the arbitrator.

The challenge to the validity of the non-competition clauses was not the only “attack” in the case, because between the lines it is clear that the Supreme Court perceived an attack by the state supreme court on the supremacy of the Federal Arbitration Act and the Court’s precedents interpreting the Act. The Court was intent on repulsing the challenge, using somewhat strong language about the state court’s having “disregarded” federal law, not to mention its “judicial hostility” observation.

The state Supreme Court had reasoned that state courts could resolve issues concerning the validity of the non-competition clauses, because a specific state statute on that subject should control over the more general Arbitration Act favoring arbitration. The Supreme Court disagreed. The principle that specific statutes control over general ones on the same subject applies only to statutes of “equivalent dignity,” and in this respect the state statute was not the equal of the Arbitration Act. If the effect of state law was to prohibit arbitration of an issue, in conflict with the Act and how it has been interpreted, the analysis is straightforward: Federal law trumps state law. Or, as the Court put it, “There is no general specific exception to the Supremacy Clause.”

To discuss your NJ arbitration matter, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com/. Please ask us about our video conferencing consultations if you are unable to come to our office.

 

 

Posted in Arbitration.