DraftKings Case Shows Limited Reach of California’s Noncompete Ban

It is no secret that California is hostile to noncompetition (noncompete) agreements. As of Jan. 1, 2024, California employers cannot enforce nor enter into noncompete provisions or agreements with an employee or prospective employee, even if the employee signed the agreement outside of California or worked outside of California. The limitations, if any, of California’s ability to control or regulate a contract negotiated in, performed in, and governed by the law of another state was not tested, until now.

About a month after California’s law came into effect, Michael Hermalyn challenged the bounds of California’s stricter regulation. Before he resigned, Hermalyn signed a noncompete agreement with DraftKings, Inc., which included a Massachusetts choice-of-law provision. DraftKings is headquartered in Massachusetts and Massachusetts generally allows noncompete agreements (save certain safeguards). Hermalyn moved to California. Three days later, he resigned as a Senior Vice President with DraftKings and joined its rival Fanatics, Inc. in California in a nearly identical role.

DraftKings sued Hermalyn in the U.S. District Court for the District of Massachusetts, alleging he breached his noncompete agreement and that Massachusetts law applies so it could enforce his noncompete agreement. The District Court sided with DraftKings, used Massachusetts law, and found Hermalyn did indeed breach his noncompete agreement with DraftKings, and preliminarily enjoined (in other words, prohibited) Hermalyn from competing against DraftKings for one year.

Hermalyn appealed the ruling to the First Circuit and asked it to instead rule: (1) Massachusetts law does not govern or (2) if Massachusetts law does govern, then the judge should have excluded California from banning him for working for competitors in California because California is so hostile to California employees of California companies working in California being confined by noncompetes.

The First Circuit took a few factors into account, (which spoiler alert, means this ruling will not be one-size-fits-all):

• Hermalyn did not work for DraftKings from California, at all. He primarily worked for DraftKings in New Jersey and New York and traveled to Massachusetts for work about once every six weeks.
• A California carve-out will have no utility: at Fanatics, Hermalyn will inevitably work with customers outside of California.
• Did the DraftKings noncompete have an effective choice of law provision?
• What are the public policy considerations?
• Who had a materially greater interest in the outcome of this case, California or Massachusetts?

The First Circuit delved into the Massachusetts Noncompetition Agreement Act, which frowns on certain categories of workers being restricted but also does allow for noncompete agreements for higher-level employees (like Hermalyn) because they have business-sensitive information and direct ties with company customers.

In light of this, the First Circuit held California does not have a materially greater interest from a public policy perspective as both states have legislation regarding noncompete agreements. It also held that it was not for the court to decide which policy is more “fundamental or compelling” than the other state’s.

And so, the noncompete ban stands and there is no special carveout just because Hermalyn breached the noncompete within California state lines.

Conclusion

The outcome may be different if this case was filed in a state without its own noncompete legislation, or if the employee moved to California for work that is connected to California exclusively, or if the employee worked in California at the employer attempting to enforce the noncompete. In other words, this is likely not the last word on testing the bounds of California’s noncompetition regulations, so stay tuned.

If you have any questions about this publication or how the DraftKings ruling may impact your noncompetition agreements, please contact Monique Eginli (meginli@clarkhill.com), Katie Sharpless (ksharpless@clarkhill.com), or another member of Clark Hill, LLP’s California Labor and Employment Practice Group.