2024-08-14 13:55:02
The ongoing battle between DraftKings Inc. and its former executive, Michael Hermalyn, remains contentious, with the District of Massachusetts’ decision to enforce Hermalyn’s non-compete now appealed and argued to the First Circuit.
Background
DraftKings, a Boston-based online sports and gaming platform, employed Hermalyn as a Senior Vice President. He resigned in February 2024, consummating negotiations with DraftKings’ direct competitor, Fanatics, to take up a near-identical role there. However, Hermalyn’s restrictive covenants with DraftKings directly prohibit, among other things, his acceptance of such a role. The agreements also provide that they are governed by Massachusetts law. Perhaps because of this, in early 2024, Hermalyn worked to transition his residence to California.
DraftKings alleges Hermalyn took with him “keys to the kingdom”-level documents, including a spreadsheet of hundreds of business partners and a playbook of DraftKings’s operations for highly valued clients. The company contends Hermalyn’s transfer to Fanatics and moves toward California residency were part of a concerted scheme to misappropriate its confidential information, poach its employees, and escape liability through California’s stringent ban on non-competes.
The case involves competing litigations: Hermalyn filed suit to nullify his restrictive covenants in California state court in Los Angeles while DraftKings successfully moved for injunctive relief to enforce them in Massachusetts federal court.
Choice of Law Battle
Procedural disputes have kept the California action relatively slow-moving. However, the Court likely must examine the recently enacted § 16600.5 of the California Business and Professions Code. Section 16600.5, aimed at strengthening California’s already stringent non-compete ban, voids non-compete agreements “regardless of where and when the contract was signed.” Prior California law already allowed most workers who primarily reside and work in California to void provisions that would require the worker to adjudicate a non-compete dispute out-of-state (although there are some exceptions). See Cal. Labor Code § 925. However, California courts have held that § 925 does not control cases whose operative facts arose outside of California or claims by plaintiffs who did not primarily reside and work in California at the relevant time.
Though the language of § 1660.5 appears unambiguous, whether that law can actually pack as significant a punch as intended is unclear, as non-compete disputes like this one often involve a complex array of choice-of-law and -forum questions. Courts have not yet addressed whether California can actually regulate a contract negotiated in, performed in, and governed by the law of another state with minimal, if any, connection to California (at least until an individual decides to decamp to California for a new employer), and the new law raises questions of Constitutional concerns as well as comity concerns. Yet Hermalyn’s success rises and falls on whether he can establish that California’s anti-non-compete policy should overtake Massachusetts’ business protections, even when a Massachusetts business contracted with an (originally Massachusetts-based) employee to select Massachusetts as the governing law.
The First Circuit appeared skeptical of Hermalyn’s argument for applying California law.[1] For instance, Judge O. Rogeriee Thompson pointedly noted: “It’s not clear to me why California’s policy concerns have greater import than Massachusetts’s.” Likewise, Judge William Kayatta questioned the possible precedent set in invalidating the non-compete when the vast majority of states allow such agreements in certain circumstances, asking whether all of these states “must create an exception that says you can compete if you move to California.” DraftKings’ counsel seized on a similar argument, contending a decision in favor of Hermalyn would invite gamesmanship to evade obligations imposed in Massachusetts. He described Hermalyn’s conduct as “egregious” and this case as being a “paradigmatic” example “for why Massachusetts businesses need protection from this sort of thing.” DraftKings’ counsel further argued that the two states are “coequal sovereigns in our system and each has passed a statute that reflects the considered policy judgments of their respective legislatures,” and that there is “no basis to say that California’s law trumps Massachusetts’s law simply because California feels more passionately about these issues.”
The First Circuit thus appears poised to reject Hermalyn’s arguments and affirm enforcement of the non-compete. If accurate, the California court will have to consider whether it can somehow take a differing approach. As yet, while the Los Angeles Superior Court has (unsurprisingly) stated Hermalyn’s case would likely prevail under California law, it denied Hermalyn’s request for an injunction, emphasizing that doing so would “have the effect of enjoining the proceedings in the Massachusetts case.” Such a decision, the Court noted, would “require[] an exceptional circumstance that outweighs the threat to judicial restraint and comity principles.” It thus remains to be seen how the California court will ultimately rule (especially if the First Circuit affirms the trial court’s injunction prohibiting Hermalyn’s role with Fanatics), and what the impact will be of two potentially conflicting decisions on the applicability and enforceability of § 16600.5.
Conclusion
Hermalyn’s odds do not appear great in the First Circuit. DraftKings’ decision to swiftly move for relief in its homebase, where non-competes remain valid if they meet certain requirements, has thus far preserved Hermalyn’s obligations. However, the California action remains active, and California has continued to bolster its non-compete ban. While both the state and federal actions here have noted Hermalyn’s argument risks judicial overstep, it remains undecided whether or not California can statutorily void contracts made out of state. Dueling judgments may make this litigation the appropriate test case for a higher court ruling on California’s ability to effectively invalidate non-competes under the laws of the 46 states that (currently) permit them. While the current case status suggests DraftKings has the edge, any future bets remain risky given the unsettled nature of the house rules in these circumstances. We will keep you updated on the action as this case develops.
[1] Certainly, the nature of the trade secret misappropriation allegations against Hermalyn, many of which the district court found credible, combined with his representations in response, which the district court found lacking in “candor,” have done him little favors.
