When contracting with another party, it is essential to understand which state law will govern your contract in the event you find yourself in a contractual dispute.  What might seem to be a reasonable provision, agreed upon by all parties, can be interpreted radically different depending upon the state law that will govern your contract.  In legalese, choosing a state’s law that will govern your contract is know as a “choice of law” provision.

In Texas, as a general proposition, the rule of “party autonomy” allows for the parties to choose a state’s law to govern their contract as they please.  However, as with most legal rules, this proposition is not absolute, and Texas imposes some limitations on this rule.  First, the state law chosen must bear a “reasonable relation to the state and parties involved.”  Parties cannot choose a state that has no relation whatsoever to their agreement or transaction.  Second, a party cannot choose the application of a state’s law that would be contrary to a fundamental policy of Texas law in which Texas has a “materially greater interest” in the dispute.

An example of the above stated rule is illustrated by way of a recent Texas Supreme Court ruling handed down last summer.  In Exxon v. Drennen, Exxon Mobil, headquartered in Texas, and a resident of Texas, working in Texas, entered into a contract involving what they thought was a non-compete agreement.  However, both parties agreed to New York being the proper “choice of law” to apply to the contract, as Drennen had worked for Exxon in New York in the 1980s, and part of his compensation involved stocks that were traded and regulated on the New York Stock Exchange.  Eventually, litigation broached the issue of which state’s law would apply, New York or Texas.

Drennen appealed arguing that Texas law should apply to the contract because the non-compete agreement was unenforceable as a matter of Texas public policy.  The appellate court held that the trial court improperly applied New York law because Texas had a “materially greater interest” in the dispute due to the entire transaction taking place in Texas.  Second, the court held that the dispute centered on a non-compete agreement, which is a fundamental matter of public policy related to employees and their mobility in the Texas workforce.  Thus, Texas law applied.

On appeal from this discussion, however, the Texas Supreme Court found otherwise.  The court ceded that Texas has the most significant relationship to the transaction, and it had a “materially greater interest” where both the employer and employee are Texas residents.  However, the Court held that the non-compete agreement being disputed was not actually a non-compete agreement under required elements of Texas’ Covenants Not to Compete Act.  Thus holding that applying New York law would not contravene a fundamental policy of Texas related to the mobility of employees in Texas.  In the end, New York law applied.

The above case demonstrates the pitfalls and potential for costly litigation when choosing a choice of law to govern a contract.  The Texas Supreme Court seems to be advancing the proposition that very minimal contacts with other states are required to establish a valid choice of law provision between contracting parties.  However, strict compliance with Texas statutory elements in cases such as non-competes are essential to make an argument that the choice of law provision thwarts a fundamental public policy of Texas.  Simply calling something a non-compete, and intending for it operate as such will not necessarily be legally treated as a non-compete depending on the state law you choose to govern your contract.