Texas Non-Compete Law Blog : Texas Non-Compete Lawyer & Attorney : Robert Wood of Fell & Wood Law Firm : Trade Secrets Law in Denton, TX

In a recent case in Houston, a state trial court's denial of an application for a temporary injunction was overturned.  In denying the requested temporary injunction, the court had failed to receive any testimony that might have supported the issuing of an injunction.  The court of appeals held that failing to receive testimnony necessitated reversal of the trial court's ruling, for the following reasons:

First,  the trial court found that the noncompete provision was not "ancillary to an otherwise enforceable agreement."  The court based this finding on the fact that the agreement did not contain an explicit promise by the employer to provide confidential information.  However, the court of appeals noted that, as a result of the Supreme Court's decision in the Mann Frankfort case, a promise to provide confidential information can be implied.  The trial court erred by not receiving testimony on whether the circumstances of the defendant's employment "necessarily involved the provision of confidential information."

Second, the trial court erred in holding that the agreement's restriction on solicitation of customers was overly broad.  The trial court based its ruling on the fact that the restriction applied to all of the employer's customers, and not merely the particular customers with which the defendant dealt.  However, as the court of appeals noted, without hearing any testimony, the trial court could not have known whether the defendant dealt with all of the employer's customers--it is possible that he did so.

The trial court's denial of the application for temporary injunction was reversed and remanded.

 

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In a recent case in a federal district court in Texas, the defendants--individuals who had signed non-compete agreements with their previous employer--contended that their agreements should not be enforceable because they were "constructively discharged" (i.e., forced to resign). 

The federal district court rejected this contention.  In doing so, the court noted that "termination of at-will employment does not invalidate a restrictive covenant and it does not give rise to a claim for constructive discharge."   The court then analyzed the facts proffered by the defendants in support of their constructive discharge claim (e.g., that their former employer had been fined by the Justice Department) and found them wanting.  The court stated that this "in no way indicates that Defendants' work conditions were so altered that a reasonable person would have felt compelled to resign."

OBSERVATION:

Although the district court rejected the defendants' constructive discharge contention in this case, it cannot be said with certainty that such an argument would fail in all cases.  The court might have viewed things differently, for example, if the defendants had quit because they had been asked to participate in criminal activity.  Or, if the employees had been employed for a definite term, rather than at will, the result theoretically might have been different.  That said, this opinion definitely supports the proposition that termination of an at-will employee does not invalidate a restrictive covenant in Texas.

 

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What happens when an employer gives an employee stock in exchange for a non-compete agreement, but the non-compete agreement is held to be unenforceable.  Does the employee still get to keep the stock?  This question was raised in a case in which the employer gave a ten percent ownership interest in the company to one of its employees.  The employer prepared a stock certificate in the employee’s name, but it retained possession of the stock certificate. 

Approximately four years after executing the agreement, the employee left the employer and took a job with a competing company.  The employer claimed that because the employee breached the non-compete agreement, he was not entitled to the stock.  The employee filed suit seeking a declaratory judgment that the stock issued in his name should be delivered to him.

The trial court ruled that the noncompete agreement amounted to an unenforceable restraint of trade and awarded the employee the stock.  The court of appeals agreed that the noncompete agreement was unenforceable, because it was unlimited as to time and extended to customers with whom the employee had no association with while working for the employer. 

However, the court also held that the employee should not receive the stock. In reaching this conclusion, the court considered whether the promise not to compete and the promise of stock were mutually dependent promises.  That is, but for the employee’s promise not to compete, the employer would not have promised to give him stock.  Because the employer did not get what it bargained for (i.e., the employee’s noncompetition), the employee was not entitled to the consideration promised by the employer (i.e., the stock).  Therefore, the employee was allowed to work for the new employer, but he lost the stock. 

As we can see from this case, an employee who challenges the enforceability of a non-compete agreement may, if he or she prevails, forfeit the consideration (in this case, stock) that was given for the non-compete.

John R. Ray & Sons, Inc. v. Stroman, 923 S.W.2d 80 (Tex. App.—Houston [14^th Dist.] 1996, writ denied).

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Texas noncompete agreements routinely contain a provision prohibiting an employee from soliciting, or doing business with, her employer’s customers (except on her employer’s behalf).  Not infrequently, these provisions preclude the employee from soliciting any of her employer’s customers.  However, some Texas cases have held that such provisions are too broad.

Several Texas cases have held that nonsolicitation provisions should only apply to the customers with whom the employee in question actually worked while she worked for the employer.  Thus, a provision keeping the employee from working with “all” of the employer’s customers might be too broad.  Other cases have held that nonsolicitation provisions should not prohibit an employee from contacting customers he had before he became employed by the employer.

In addition, Texas courts have held that nonsolicitation provisions must meet the same rigorous standards applicable to noncompete agreements.  That is, they must me “ancillary to an otherwise enforceable agreement” and reasonable in scope.  Conversely, nondisclosure agreements, which do not constitute restraints upon trade, are not analyzed in the same way as noncompete agreements.

OBSERVATION:

Just as Texas courts are hostile to noncompete agreements that are overly broad, they also frown on nonsolicitation agreements that are too broad.  Whenever an employer attempts to prevent one of its former employees from soliciting or doing business with one of the employer’s customers, the provision must be examined to ensure that it is reasonable in scope.

 

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Assuming a non-compete agreement in Texas is worded properly and supported by adequate consideration, the next question is whether the restrictions contained in the agreement are reasonable.  Texas courts have routinely held that the scope of the restrictions should bear some relationship to the activities that the employee performed for his former employer.  For example, if an employee performs work for his employer only in the Dallas/Fort Worth area, a non-compete agreement that keeps him from competing with his employer anywhere in the State of Texas might be too broad.  The facts of each case must be assessed on their own merits, obviously.  However, in considering whether a particular noncompete agreement is reasonable, Texas courts have consistently focused upon where an employee performed his job duties for the employer.

 

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For a non-compete agreement to be enforceable in Texas, the consideration given by the employer to the employee must “give rise” to its interest in restraining competition.  In other words, the employer should be able to go into court and say, “Because we gave our former employee x, he should be precluded from competing against us.”  Over the years, employers have tried to justify non-compete agreements based upon many different forms of consideration—e.g., providing the employee with a term of employment, or stock options, or severance, etc.

However, the only type of consideration that Texas courts have consistently believed sufficient to justify non-compete agreements in the employment context has been the employer’s providing of confidential information to the employee.  Texas courts have believed the employer’s argument—“We gave him confidential information; thus, he shouldn’t be allowed to compete with us”—to be convincing.

However, in the Sheshunoff case, the Texas Supreme Court warned against “overly technical disputes” involving noncompete agreements.  The court warned that lower courts should not get bogged down in questions about “the amount of information an employee has received, its importance, its true degree of confidentiality, and the time period over which it is received.”

This warning arguably reflects the court’s growing impatience with disputes involving non-compete agreements.  Prior to Sheshunoff, the striking down of noncompete covenants, on what some people might refer to as “technical” grounds, was fairly routine.  The supreme court may be signaling its desire for a simpler test to determine whether noncompete agreements are enforceable in Texas.

However, this warning has not kept some Texas courts from continuing to insist that non-compete covenants be supported by adequate consideration.   For example, in a recent Dallas Court of Appeals case, the court held:

Sheshunoff did not purport to replace the requirement that there be consideration for a non-compete agreement. Instead, the sufficiency of the consideration may become part of the reasonableness test after the court first determines there was some consideration.

OBSERVATION:

The Texas Supreme Court’s warning against “overly technical disputes” must be squared with the requirement that the employer’s consideration must “give rise” to its interest in restraining competition.  One potential way of harmonizing these competing concerns is to consider the true confidentiality of the information provided by the employer at the “scope” stage if the analysis.  In other words, an employee bound by a non-compete agreement could challenge whether the alleged confidential information conveyed by the employer truly justifies the restrictive covenant in question.

 

 

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Texas non-compete agreements can be enforceable in the context of at-will employment.  However, if the only promise made by the employer in the agreement is to hire the employee on at at-will basis, the agreement will fail for lack of consideration.  With few exceptions, for a non-compete agreement to be enforceable in Texas, the agreement must contain either an express or implied promise by the employer to provide confidential information to the employee.  Also, the agreement should contain a return promise by the employee not to use or disclose the employer’s confidential information.  These promises can create a binding non-compete agreement in Texas even in the context of at-will employment.

 

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For several years in Texas, non-compete agreements that arose in the context of at-will employment were invalidated by Texas courts because there was a gap in time between when the employee signed the non-compete agreement and when he received the consideration (i.e., confidential information) from the employer.  Texas courts reasoned that since the employer theoretically could have terminated the employee between the time he signed the agreement and the time when the employer conveyed the information, the employer’s promise to provide the information was “illusory” (meaningless) when it was made.  Thus, even if the employer did in fact provide confidential information to the employee, the non-compete agreement would be held to be unenforceable.

This changed when, in 2006, the Texas Supreme Court handed down its opinion in the Alex Sheshunoff case.  In that case, the court held that a “unilateral contract formed when the employer performs a promise that was illusory when made can satisfy the requirements of the Act.”  Thus, in a situation in which (a) an employee was employed “at will”; (b) the non-compete agreement contained a promise by the employer to provide confidential information to the employee; and (c) the employer provided confidential information to the employee, the agreement would become enforceable at the time the confidential information was conveyed.

OBSERVATION:

Sheshunoff was a critically important decision, because it made enforceable many non-compete agreements that otherwise would have been unenforceable (i.e., those in which the at-will employee was provided with confidential information sometime after he signed the agreement).  After Sheshunoff, the key inquiry is whether the employee actually received confidential information from the employer. If he did, the non-compete agreement may be enforceable.

 

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To be enforceable in Texas, non-compete agreements must be supported by adequate consideration.  In the employment context, the only kind of consideration that the courts have consistently held to be adequate is the employer’s providing of confidential information to the employee.  This is not to say that financial consideration—such as the providing of company stock—can never be sufficient.  However, generally speaking, for a non-compete agreement to be enforceable in the employment context, the employer must provide confidential information to the employee.  This has been the case in Texas for many years.

Until last year, it had also been true in Texas that a non-compete agreement, to be enforceable, had to be worded in a certain way.  Specifically, the agreement had to contain an affirmative promise by the employer to provide confidential information to the employee.  Thus, in some cases, Texas courts held that covenants not to compete were unenforceable because they did not contain a promise by the employer to provide confidential information to the employee (and this was so even if the employee did, in fact, receive confidential information from the employer).

This all changed last year.  In April 2009, in the Mann Frankfort case, the Texas Supreme Court held that a non-compete agreement could be enforceable even if it did not contain an explicit promise by the employer to provide confidential information.  The court held that, in some situations, the employer’s promise to provide confidential information could be “implied.”  The court noted:  “When the nature of the work the employee is hired to perform requires confidential information to be provided for the work to be performed by the employee, the employer impliedly promises confidential information will be provided.”

OBSERVATION:

The effect of the Mann Frankfort decision was to make enforceable many non-compete agreements in Texas that otherwise would have been unenforceable.  Now, in some circumstances, a court will see in a non-compete agreement an implied promise to provide confidential information, even though the agreement does not contain an express promise.  The key inquiry is whether the employee’s job duties are such that the conveying of confidential information would be required.  If the answer is yes, and if confidential information is in fact imparted to the employee, then the agreement may be enforceable.

 

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