Oklahoma Supreme Court holds that an agreement to arbitrate does not prohibit judicial review of agreements containing competitive restrictions

An agreement to arbitrate does not prohibit judicial review of a non-competition agreement

On November 22, 2011, the Supreme Court of the State of Oklahoma held on appeal that an arbitration provision intended to hear all disputes in an employment agreement containing restraints of trade did not prohibit judicial review of those provisions where Oklahoma adopted a public policy against such restraints. Howard v. Nitro-Lift Technologies, LLC, 2011 OK 98 (2011).

While the holding may appear in harmony with past decisions, the Oklahoma Supreme Court took an unusual turn in Howard by reviewing the non-competition agreement as a gateway matter. Generally, a Federal or State court will enforce a parties’ agreement to arbitrate and submit all appropriate disputes to arbitration. But a court has primary jurisdiction to determine the validity of an arbitration agreement as a gateway matter before arbitration. Accordingly, the Oklahoma Supreme Court established in previous cases that an Oklahoma court may again review the validity of a non-competition agreement after it was already resolved in arbitration. See, e.g., Cardiovascular Surgical Specialists, Corp. v. Mammana, 2002 OK 27 (2002) (holding that an arbitrator’s decision on the validity of a non-competition agreement did not prevent a subsequent judicial review of the same); see also Wyatt-Doyle & Butler Engineers, Inc. v. City of Eufaula, 2000 OK 74 (2000). But in Howard, it suggested that the Oklahoma judiciary had primary authority over the question of enforceability of an agreement to restrain freedom of trade, not the arbitrator.

Relevant Facts

Nitro-Lift produces nitrogen for use on oil and gas well sites (i.e., “nitrogen generation”). Between 2008 and 2010, it employed Plaintiffs Eddie Lee Howard and Shane Schneider as field workers. During that time, the employees signed identical employment agreements that prohibited them, if they left Nitro-Lift, from 1) working for two years for any company in the United States, which made at least 5% of its revenue from nitrogen generation (a field in which Nitro-Lift specialized); and 2) soliciting Nitro-Lift’s employees or customers for a competitor (collectively, “Competitive Restrictions”). The employment agreements also provided that any disputes would be resolved by arbitration in Houston, Texas and according to Louisiana law, which gives more favorable treatment than Oklahoma law to enforcing non-competition agreements. See, e.g., Ticheli v. John H. Carter Co., 996 So. 2d 437 (La. App. 2d Cir. 2008) (finding a non-competition agreement enforceable even though it was not defined in geography or time). In 2010, each employee quit Nitro-Lift after a dispute over the long hours worked and lack of overtime compensation, and each began work for an Arkansan competitor.

In July 2010, Nitro-Lift filed a demand for arbitration in Houston, alleging that the employees had breached the Competitive Restrictions. It also sought to enjoin the former employees from disclosing or using its trade secrets about nitrogen-generation.

On October 14, 2010, the employees filed a declaratory judgment action in the District Court of Johnston County, Oklahoma seeking the court to declare the Competitive Restrictions void under Oklahoma public policy and to enjoin enforcement of the Competitive Restrictions. The employees also asserted that they never acquired any of Nitro-Lift’s trade secrets as “manual laborers” in the field working on truck gauges, and rarely dealt with the company’s customers. Nitro-Lift, however, countered that employees were “thoroughly trained technicians” who obtained a “significant amount of confidential information and training concerning the implementation of specialized, [proprietary] equipment and procedures.”
On November 9, 2010, Nitro-Lift filed a motion to dismiss, arguing that: 1) the arbitration clause was valid and 2) the enforceability of the Competitive Restrictions should be submitted to the arbitrator in Houston.

On November 23, 2010, the district court issued a final order dismissing the employees’ motion for a TRO and granting Nitro-Lift’s motion to dismiss. Acknowledging that the enforceability of an arbitration clause (i.e., “arbitrability”) was a “gateway” matter for the judiciary, the court found that the arbitration agreement in the employment agreements was valid on its face and reasonable in its terms. Therefore, it said any dispute between the employees and Nitro-Lift, including enforceability of the Competitive Restrictions, should proceed in the arbitration Nitro-Lift had filed in Houston. The court further found the Competitive Restrictions were temporally reasonable in light of Nitro-Lift’s “legitimate interest in the protection of its confidentialities and proprietary matters.”

Parties’ arguments on appeal to the Supreme Court of the State of Oklahoma

On December 14, 2010, the employees appealed to the Oklahoma Supreme Court asking it to decide whether an employer could avoid Oklahoma’s public policy against restraints of trade by providing in the employment agreements that disputes regarding Competitive Restrictions would be resolved through arbitration applying a foreign State’s law. They argued that the Competitive Restrictions could not be enforced because they were contrary to Oklahoma’s public policy against restraints of trade as provided in 15 Okl. St. §§217 and 219A. See, e.g., Oliver v. Omnicare, Inc., 2004 Ok. Civ. App. 93, 5-7 (Ok. Civ. App., Div. 1 2004) (holding that a choice of law provision will be upheld only if the underlying agreement does not violate Oklahoma public policy).

15 Okl. St. §217 provides that “[e]very contract by which any one is restrained from exercising a lawful profession, trade or business of any kind, [except as otherwise provided in this title or act], is…void.” 15 Okl. St. §219A further provides that that:

A former employee shall be permitted to "engage in the same business as that conducted by the former employer or in a similar business,” notwithstanding any non-competition agreement, as long as the former employee does not directly solicit goods and services from the former employer’s established customers. “Any provision in a contract between an employer and an employee in conflict with the provisions of this section shall be void and unenforceable.”

The employees further argued that Nitro-Lift could not skirt Oklahoma’s policy against enforcing non-competition agreements by a choice of law provision applying Louisiana’s law.

Nitro-Lift pointed out in response that the only issue in the case was the validity of the arbitration clause in the employment agreements and argued that the enforceability of the Competitive Restrictions should be reserved for the arbitrator. They so argued on the basis of Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395 (1967) and its progeny, in which the U.S. Supreme Court held that a federal court may only consider issues relating to the making and performance of the arbitration agreement. Id. at 404. As a result, absent an invalid arbitration clause, the enforceability, validity or legality of an agreement as a whole must go to arbitration as provided by the arbitration agreement. See Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 449 (2006). Nitro-Lift further argued that the district court appropriately found the arbitration clause to be valid because the employees did not show that the arbitration clause was a product of fraud in the inducement or duress. It therefore concluded that the employment agreements and the Competitive Restrictions should be submitted to arbitration.

Decision of the Supreme Court of the State of Oklahoma

On November 22, 2011, the Court reversed the district court’s final order and remanded the case. It held that the arbitration agreement did not prohibit judicial review of the Competitive Restrictions, relying on a principle in Oklahoma law that allowed specific state statutes, namely 15 Okl. St. §§217 and 219A, to govern over a more general statute favoring arbitration, such as the Federal Arbitration Act, 9 U.S.C. §§1 et seq., and the Oklahoma Uniform Arbitration Act, 15 Ok. St. §§801 et seq. and 12 Ok. St. Supp. §§1851 et seq. See Bruner v. Timberlane Manor Ltd. Partnership, 2006 OK 90 (2006) (holding that a specific statute in Oklahoma’s Nursing Home Care Act addressing the right to commence an action and to have a jury trial governs over the more general statute favoring arbitration). Here, 15 Okl. St. §§217 and 219A generally voided non-competition agreements and, in effect, removed the enforceability of such agreements from arbitration as a matter of public policy. Howard, 2011 OK at fn.21.

The Oklahoma Supreme Court also found the Competitive Restrictions void and unenforceable under 15 Ok. St. §219A. It declared that the “unmistakable, unambiguous” language of §219A “prohibit[ed] employers from binding employees to agreements which bar their ability to find gainful employment in the same business or industry as that of the employer.” Applying §219A to the Competitive Restrictions, the Oklahoma Supreme Court concluded that the Competitive Restrictions “[went] well beyond the bounds of what is allowable under §219A and violat[ed] the legislatively expressed public policy.” The Competitive Restrictions could plausibly prevent the employees from taking any jobs in any directly or indirectly competing business and from soliciting not only Nitro-Lift’s established customers and clients, but also the company’s past customers and clients. It also conceivably prevented the employees from employing or engaging other Nitro-Lift employees seeking employment elsewhere on their own initiative. The Oklahoma Supreme Court further concluded that judicial modification of the Competitive Restrictions would be inappropriate because the provisions would have to be “substantially excised, leaving only a shell of the original agreement.”

The Court’s opinion was unanimous.

Impact of the decision on protection of employer’s trade secrets

Two lessons emerge from Howard for an employer seeking to protect its trade secrets in Oklahoma courts.

First, the action and reasoning of the Oklahoma Supreme Court suggest that an employer cannot compel a former employee to adhere to Competitive Restrictions through a claim in an arbitration proceeding based on vague allegations of trade secrets misappropriation, which does not fall under an exception to Oklahoma’s public policy against restraints of trade. A claim for trade secrets misappropriation and a violation of the Competitive Restrictions stands or falls on its own. The Court in Howard fleetingly noted that Nitro-Lift believed the Competitive Restrictions were necessary to protect its trade secrets but did not discuss any of (a) what was the substance of NL’s alleged trade secrets, (b) what efforts did NL exercise to keep them secret, (c) what evidence was there that the employees had either misappropriated the trade secrets or were about to do so, or (d) whether, even assuming reasonable efforts had been taken to preserve their secrecy, those alleged trade secrets were protectable or were generally known or readily ascertainable. See 78 Okl. St. §85 et seq. The Court held that the Competitive Restrictions were void as a matter of legislative policy expressed in 15 Okl. St. §§217 and 219A, and the protection of an employer’s trade secrets is not a recognized exception to the general prohibition against restraints of trade in §217. In short, Nitro-Lift’s failure to pursue a claim for trade secret misappropriation against the employees in either the Houston arbitration or the Oklahoma litigation no doubt added to the skepticism of the Supreme Court as to whether Nitro-Lift actually believed its trade secrets had been or were clearly about to be misappropriated.

Second, an employer seeking to protect trade secrets in a situation such as in this case should not rely on its ability to bring an preemptive action for trade secret misappropriation. Instead, it should ensure, in the conduct of its business, that if it such a claim arises someday under Oklahoma’s Uniform Trade Secrets Act, 78 Okl. St. §85 et seq., it has taken the appropriate steps long beforehand to protect those secrets. Otherwise, it will lose the case for its failure to meet a fundamental rule of trade secret law, that the owner of a trade secret has exercised reasonable care to present the misappropriation of that secret. Nitro-Lift’s apparent silence on the substance of the misappropriation claim it included in its arbitration demand appears to be a tacit admission that this claim was for color only and had no substance.

Generally, federal and state courts enforce arbitration provisions in agreements within the courts’ jurisdiction unless the courts find that the arbitration provision is invalid. However, despite the fact that Nitro-Lift resisted submitting the question of whether the restraints of trade were valid to arbitration, the Oklahoma Supreme Court held that the Oklahoma judiciary had primary authority over the question and not the arbitrator.