Texas Contract & Noncompete Disputes Blog

Texas Contract & Noncompete Disputes Blog

Texas Non-Compete, Trade Secrets and Contract Law

Texas Noncompete Agreements Must Be Reasonable in Scope

Posted in Noncompete Agreements

Hiring employees, training them, and granting them access to industry secrets or client lists exposes employers to the possibility that employees will utilize this valued information against them.  In order to protect themselves, employers will often include a covenant not to compete provision in an employment contract, commonly known as a “non-compete.”  However, it is important for both employers and employees to understand the legal limits of a non-compete.  Drafting a non-compete that is too broad can lead to counterproductive results, while drafting one that is too narrow might be ineffective in protecting your economic interests and business goodwill.

In Texas, a covenant not to compete must state a duration of time, geographical area to be limited, and scope of activity to be restrained that is reasonable to protect goodwill and other business interests of the employer.  It is important to also remember that the non-compete provision must be ancillary or part of an otherwise enforceable agreement or contact.  The “reasonableness” of a non-competition agreement is a question of law that a court must decide.  As a general matter, except for a few unique circumstances, a non-competition agreement that is indefinite or without geographical limitations will be ruled unreasonable and unenforceable.

For example, the Dallas Court of Appeals recently held that independent contractors are subject to covenants not to compete. However, the same “reasonableness” standard applies.  In that case, the plaintiff was an independent contractor selling insurance policies pursuant to an agent agreement with the defendant.  Part of the agent agreement contained a covenant not to compete that prevented the plaintiff, upon termination or resignation, from “attempting to replace business with any policyholder by soliciting or offering competing policies…to which Agent sold any policy of insurance pursuant to this agreement.”  The Dallas Court of Appeals held that this term was unenforceable because there was no duration on time, as policyholders of the defendant could renew their policies indefinitely, thus leading to the plaintiff not being able to solicit or offer policies to them forever.  The result of the holding was that the plaintiff could compete with defendant immediately.

The above case is an example of an employer thinking it had sufficiently protected its economic interests, only to find out that its non-competition agreement was ineffective.  It is important for employers to understand Texas non-compete law so that they can effectively protect their economic interests and business goodwill.  For employees, knowing the limits of covenants not to compete in Texas will prevent them from being unlawfully restricted in offering their unique skills and services.

Oral Promises Enforceable in Texas

Posted in Noncompete Agreements

“An oral contract is as good as the paper it is written on”—this is simply not true.  In fact, a Texas jury awarded $11 billion dollars in damages to Pennzoil when Texaco interfered with an oral contract for the sale of Getty Oil to Pennzoil, one of the largest jury verdicts in U.S. history.  While it is true that some contracts must be in writing, such as the sale of real estate, Texas courts will enforce many oral promises.  To understand the concept of an oral contract, we first need to know the elements of a valid contract.

According to Texas law, a contract is a promise(s) with legal consequences that are formed when an offer is made, the offer is accepted and valuable consideration (money, services, etc.) is exchanged for the promise(s).  In determining the existence of an oral contract, Texas courts look to the communications between the parties and to the acts and circumstances surrounding those communications.  Furthermore, a breach of an oral contract occurs when (1) there is a valid contract, (2) a plaintiff performs its obligation, (3) the defendant breaches his obligation and (4) the plaintiff sustains damages from the breach.

Oral promises can have disastrous consequences.  An example is seen in a case decided by the Houston Court of Appeals in 2012.  In that case, the trial court awarded an employee $42,500.00 in damages for breach of an oral contract promising her an end-of-year bonus.  The court of appeals affirmed the trial court’s ruling.  That court stated that there was sufficient evidence of an oral contract when the vice-president of operations for a family-run business told an employee that she would receive a bonus for work performed during the previous calendar year.  The employer argued that it told the employee she “might” receive a bonus.  However, the court found that a reasonable jury could find that an oral contract was formed from the evidence presented at trial.  The result: The employer was on the hook for $42,500.00 due to the employee.

From oil giants to small business owners, Texas courts have no problem enforcing oral promises if they meet the requirements of a valid contract.  The above case is a cautionary tale to employers, as well as employees in certain circumstances, to choose their words wisely when making oral promises.  The enforcement of an oral promise ultimately turns on the communications between the parties and to the acts and circumstances surrounding those communications.

Choice of Law in Texas Noncompete Litigation

Posted in Noncompete Agreements

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.

A Rare Anti-Noncompete Case in Texas

Posted in Noncompete Agreements

An employee of a small manufacturing company (“Acme Company”) leaves and starts his own competing company (“Best Company”). Acme Company sues the employee for doing so—because the employee signed a noncompete agreement stating that, if he left Acme Company, he would not start a competing business.

In the lawsuit, the employee argues, “The existence of my new company, Best Company, benefits the public. Having another manufacturing company will force Acme Company to constantly improve the quality of its products and to sell them at reasonable prices. In other words, competition is a good thing.”

In determining whether to enforce the noncompete agreement against the employee (by forcing the employee to shut down Best Company), should the court consider how the public will be affected if the noncompete is enforced? A layperson might answer this question, “Obviously, yes,” but that is not typically how Texas courts have dealt with the issue in the past. But a recent case may change things.

Texas Noncompete Agreements: Basic Requirements

Under Texas law, a noncompete agreement is enforceable if it is supported by sufficient consideration and is reasonable in scope. The Texas noncompete statute does not explicitly state that, to be enforceable, a noncompete agreement must be beneficial (or not harmful) to the public.

Getting an Injunction in Texas State Court

In a noncompete case, the real “trial” of the case often happens 14 days after the lawsuit is filed—at the temporary injunction hearing. At this hearing, the plaintiff asks the court to force the defendant to comply with the noncompete agreement. In our hypothetical example, Acme Company would ask the court to “make my former employee shut down Best Company.”

Under Texas law, in deciding whether to grant the injunction sought by Acme Company, the court would focus on these factors: whether Acme Company has a valid legal claim, whether Acme Company is likely to prevail at the final trial of the case, and whether—without an injunction—Acme Company would suffer irreparable harm. If the court were to answer all of these questions in the affirmative, a temporary injunction should issue.

But, under Texas state law, the court would not be required to co6nsider whether the injunction sought by Acme Company would harm the public.

The Federal Court Difference

Unlike in Texas state court, if a noncompete lawsuit is filed in federal court and a preliminary injunction is sought, a federal judge will grant the injunction only if the injunction would “not disserve the public interest.” In other words, in federal court, unlike in state court, the court must consider whether the requested injunction would harm the public.

The Recent Potentially-Groundbreaking Case in Texas State Court

In a recent case in Texas state court, the court considered how the public would be affected if the requested injunction were entered. The case involved a dispute between two doctors who worked together in the same medical practice. One of the doctors left the practice and started a competing business. The other doctor sued to enforce a noncompete agreement.

In denying the requested temporary injunction, the trial court noted, “We’re a small ccommunity. The public interest would be adversely affected” if the inthejunction were granted. The court added that there was a need for cardiologists in “this small community.” The doctor seeking enforcement of the noncompete agreement appealed.

The court of appeals affirmed the trial court’s decision to consider the effect that the noncompete would have on the public. The court explained:

Whether an agreement will be unenforceable on public policy grounds will be determined by weighing the interest in enforcing agreements versus the public policy interest against such enforcement. On one side of the scale is Texas’ general policy favoring freedom of contract. Courts weighing this interest should consider the reasonable expectations of the parties and the value of certainty and enforcement of contracts generally. On the other side of the scale is the extent to which the agreement frustrates important public policy. It is appropriate to consider whether enforcement of the covenant not to compete would harm the public interest by resulting in inadequate healthcare or continuity of care and depriving the public of access to the physician of its choice.

Possible Impact

That this case involved whether residents of a rural community would have adequate access to healthcare certainly may have impacted the ruling in this case. Nevertheless, after a wave pro-enforcement cases in recent years, the possibility that Texas courts might now consider the effect that enforcing a noncompete agreement might have on the public is potentially huge. We will have to see how this plays out in subsequent cases. The Texas Supreme Court’s refusal to hear the case may suggest that it approves of the approach taken in this case.

When is a Nondisclosure Agreement Actually a Noncompete?

Posted in Nondisclosure Agreements

Many wars have been fought in Texas courts over the enforceability of noncompete agreements. But relatively few have been waged over the enforceability of nondisclosure agreements. The reasons for this are many, including the fact that Texas courts have routinely held that, unlike noncompete agreements, nondisclosure agreements do not restrain trade; hence, they are far more enforceable. Also, litigation over nondisclosure agreements has been relatively sparse because these agreements typically only require a departing employee to refrain from using or disclosing his former employer’s trade secrets. Nondisclosure agreements typically do not prohibit an employee from competing.

But what if a nondisclosure agreement goes too far? What if the wording of a nondisclosure agreement is so broad that it is, de facto, a noncompete agreement? In that case, would the usual deference given to nondisclosure agreements apply?

What if, for example, a nondisclosure agreement prohibited an employee not only from using or disclosing his former employer’s trade secrets, but also prohibited him from using or disclosing any of the knowledge he gained while working for the employer? Would a clause like that be as enforceable as a run-of-the-mill NDA?

Nondisclosure Agreement Defined

The first step in answering this question is to examine how courts have defined nondisclosure agreements. As one Texas court put it, “Nondisclosure covenants prevent the disclosure of confidential information and trade secrets.” Another court noted, “Nondisclosure covenants do not necessarily restrict a former employee’s ability to compete with the former employer by using the general knowledge, skill, and experience gained from his or her work experience.” As these cases acknowledge, a nondisclosure agreement is designed to protect a company’s confidential information and trade secrets from being used against it—it is not designed to keep a former employee from competing by using his general knowledge and skills.

Impact of Having Overly Broad Nondisclosure Agreement

If an NDA is so broad that it “has the practical effect of prohibiting the former employee from using, in competition with the former employer, the general knowledge, skill, and experience acquired former employment,” it may be held to be a noncompete agreement. The reason for this is that if a purported nondisclosure agreement goes beyond merely protecting an employer’s trade secrets and confidential information, it may actually restrain trade, just as a noncompete does.

Why Does It Matter?

If a Texas court construes an agreement as a legitimate NDA, it will almost certainly enforce it. Texas courts have consistently held nondisclosure agreements to be enforceable. Conversely, noncompete agreements, to be enforceable, must meet the strict requirements of Tex. Bus. & Comm. Code § 15.50. For example, a noncompete agreement must be reasonable in scope. If an employee convinces a court that a nondisclosure agreement prohibits him from using his “general knowledge and skills,” the court may treat the nondisclosure as a noncompete agreement. Under the statute, an overly broad noncompete agreement must be reformed to make it reasonable.

So what?, an employer might ask. Here’s why it matters: Under the Texas statute, if the court is required to reform a noncompete agreement to make it reasonable in scope, no damages can be recovered (on a breach of contract theory) based upon pre-reformation violations of the agreement. From the perspective of the employee who is being sued, reformation of an overly broad agreement is a “get out of jail free” card—it wipes away what has happened in the past (on a contract theory; obviously, if the employer can make a tort theory, like trade secret theft, that’s a different matter). Thus, if an employer wants to maintain its right to recover damages for breach of a nondisclosure agreement, it should ensure that the agreement is reasonable in scope at the outset. The employer does not want the the court to have to reform its covenants because they are too broad.

Conclusion

In the realm of noncompete and nondisclosure agreements, “more” is not always better. Employers have an incentive to draft reasonable covenants so that the court will not have to reform them. If a court has to reform an overly broad covenant, it can have the effect of absolving the employee of wrongs that occurred before the reformation happened. Therefore, precision in the drafting of these agreements is extremely important.

Real Estate Disputes–Texas Breach of Fiduciary Duty Law

Posted in Breach of Fiduciary Duty

A recent real estate dispute sheds light on what is required to prove a breach of fiduciary duty claim in Texas. In this case, potential homebuyers contracted to buy a home for $180,000. The seller, the listing agent, the appraisal district, and the real estate agent all indicated that the home’s living area was 2722 square feet.

However, the prospective buyers told the real estate agent that the home looked smaller than 2722 square feet. The agent responded that the home looked smaller because it had an “open floor plan.”

The day before the closing was to occur, the prospective buyers told the agent that they wanted out of the transaction. The agent responded, “You can’t back out or you will get sued.” Thus, the buyers completed the transaction.

After doing so, the buyers had the local appraisal district remeasure the home. It turned out that the buyers’ suspicions were correct: the home was only 1967 square feet in size.

The buyers then sued the real estate agent. Several claims were asserted, including breach of fiduciary duty.

The district court granted summary judgment for the real estate agent, and the appellate court affirmed. The court held that there was no evidence that the real estate agent knew or should have known that the home was smaller. The agent reasonably relied upon all of the other representations, including those made by the appraisal district.

This case is a good reminder that not all “wrongs” can be fixed via the legal process. In this case, the buyers arguably should have done more to test the accuracy of their suspicions before they closed on the purchase. After buying the home, their options were much more limited, and, as the court held, they had no good legal claim against the real estate agent.

To Be Enforceable, Settlement Agreements in Texas Must Be Carefully Worded

Posted in Uncategorized

A recent Texas appellate decision demonstrates the importance of ensuring that settlement agreements are properly worded. In the case, three employees of Company A left and formed Company B. Company A sued the former employees, as well as Company B, for misappropriation of trade secrets and unfair competition.

As often happens in unfair competition cases, the parties entered into a settlement agreement. The settlement agreement provided that Company B and the individual defendants would not “knowingly initiate contact with any individual or entity who was actually known by [Company B] and the Individual Defendants prior to the direct contact . . . to be a client of [Company A].”

The settlement agreement also contained a liquidated damages provision requiring payment of $50,000 in damages merely for knowingly initiating contact.

Company A later sued Company B and its former employees for allegedly contacting two of Company A’s clients. Company A claimed that its former employees had, while they were employed by Company A, worked with these clients and thus knew who they were.

In response, Company B and the individual defendants argued that the alleged clients were actually “former” clients of Company A, and thus were not covered by the settlement agreement. The trial and appellate courts agreed with the defendants.

The potential importance of this case is that if a client is a “former” client, then a prohibition against contacting or doing business with that client may not be effective. This could come into play, for example, with respect to a client which is not currently sending business, but which could be reasonably expected to do so in the future. In other words, if a repeat client is not currently doing business with one of its vendors, does that mean that it is no longer a client of the vendor? The dissent in this case made a similar point. We will have to see the ramifications of this decision in future cases. In the meantime, lawyers who are drafting settlement, noncompete and nonsolicitation agreements meant to protect their clients’ customers should be aware of this opinion, and should perhaps draft restrictions that apply both to current and former customers.

Texas Appeals Court Reverses Denial of Temporary Injunction in Noncompete Case

Posted in Noncompete Agreements

Once again, a Texas appellate court sides with a company suing to enforce a noncompete agreement.  This time, the employer sued a former employee for violating a covenant prohibiting the employee for competing for three years following the termination of his employment.  Significantly, the noncompete covenant contained no geographic restriction.  It did not, for example, prohibit the employee from working only in the state of Texas.

When the employee went to work for a competitor, the employer filed suit, obtained a temporary restraining order, and then sought a temporary injunction.  The request for a temporary injunction was denied.  In denying the request, the trial court held that the noncompete was “unenforceable due to a lack of consideration.”  The court also held that the agreement was unenforceable due to a lack of any geographic restriction.

The Fort Worth Court of Appeals overruled the district court. The court of appeals considered the following points:

Sufficiency of Consideration: Implied Promise to Provide Confidential Information

The noncompete agreement (which was actually called an Employee Technology Agreement) stated that the employee would receive the following consideration: “continuing employment” and “salary or wages.” On appeal, the employee argued that a mere promise for continued employment was legally insufficient.

Rather than specifically address this argument, the court of appeals, citing the Texas Supreme Court’s Mann Frankfort case, held that the agreement contained an implied promise by the employer to provide confidential information. This confidential information was sufficient consideration for the noncompete covenant, the court held.

“But I didn’t really need the confidential information that was given to me,” the employee argued. The court rejected this contention. “The relevant inquiry,” the court held, “is not whether Liss’s job could has been performed without Tranter’s confidential information but whether it was performed without the confidential information.”

The court found it significant that the employee admitted to having received some company confidential information. The court noted, “The consideration requirement was satisfied by Tranter’s performance in disclosing its confidential information to Liss in exchange for Liss’s promise to keep that information confidential.”

Reasonableness of Restrictions

The court agreed with the employee that the noncompete was “unreasonable and unenforceable as written” because it did not contain a geographic restriction, as required by Texas law. However, the court noted that, as a final remedy in the case, the trial court would be required to reform the noncompete (by supplying the missing geographic restriction). Because of this, the court held, the agreement should be reformed on an interim basis, at the TI stage. The appellate court remanded the case to the trial court to do so.

Probable, Imminent and Irreparable Injury

The appellate court reaffirmed the requirement that, to obtain a temporary injunction, the applicant must prove that, without the injunction, it will be irreparably harmed. The court held that a “highly trained employee’s continued breach of a noncompete agreement creates a rebuttable presumption that the employer is suffering an irreparable injury.” Then, in reversing the district court’s denial of the application for temporary injunction, the court noted that (a) the employee was directly competing in the same territory and for the same customers; and (b) even though the employee was not actively trying to use his former employer’s confidential information, “there was no evidence rebutting the presumption that Liss would have extreme difficulty in not indirectly applying some of that confidential knowledge in his position at PMC.”

Conclusion

There are at least a couple of takeaways from this case. First, although we didn’t need anymore reminders that noncompete agreements are enforceable in Texas, this case makes that point once again. But the second point is this: Even with an enforceable noncompete agreement, a district court faced with an application for temporary restraining order or temporary injunction must carefully test the plaintiff’s contention that it needs the injunction to prevent irreparable harm. Even though there may be a rebuttable presumption that violation of a noncompete agreement will result in irreparable harm, as we can see in this case, that is not the end of the story. The plaintiff still must make a particular showing of irreparable harm. A plaintiff must be prepared to make the case that it will be irreparably harmed without an injunction.   

Misconceptions Concerning Noncompete Agreements in Texas

Posted in Noncompete Agreements

On the street, there are many misconceptions about noncompete agreements in Texas.  One myth is that, for a noncompete to be enforceable, the employer must have given the employee a cash payment, or a promotion, or some other monetary benefit.  But this is not the law in Texas. 

Usually, what the employer provides to the employee as consideration for the employee’s promise not to compete is confidential information.  Thus, by allowing the employee access to its confidential customer, pricing, and other information, the employer creates the justification for the employee’s return promise not to compete.  Typically, this confidential information is disseminated to the employee in an informal way (usually, the employee simply accesses the information through his normal job duties).

 

Thus, if you are an employee bound by a noncompete agreement, the agreement can be enforceable even though you have not received a new monetary benefit.  Simply performing your routine job duties (which includes accessing your employer’s confidential databases) may be enough to make your noncompete agreement enforceable.

In Texas, Noncompete Violation Per Se Can Justify Injunction

Posted in Noncompete Agreements

Are noncompete agreements enforceable in Texas? You bet they are—more than ever. You know it’s bad news for the employee who is being sued when a court opinion starts with: “Texas law presumes a party has read and knows the terms of the contract that he has signed.” Ever since the Marsh USA decision, Texas courts have increasingly had a “You signed it, it’s enforceable” mindset.

Of course, that’s not the end of the story. In every case, the court must determine whether the employer actually provided the consideration it promise to provide. And the court must ensure that the scope of the noncompete is reasonable.

And perhaps even more importantly, the court must determine whether the employer suing to enforce a noncompete agreement is entitled to a temporary injunction. To a large extent, the party who wins the temporary injunction hearing wins the case. The reason for this is that, if the employer wins the TI hearing, the employee either cannot work for a competitor or will have other significant restrictions placed upon him. Conversely, if the employee prevails at the TI hearing, he may be able to compete with his employer at least until the final trial on the merits.

A recent federal case from the Southern District of Texas shows how this plays out in practice. In that case, the defendant (a former employee) had allegedly engaged in some very serious misconduct (i.e., use and disclosure of his former employer’s confidential information). The employer sued and sought, among other things, a preliminary injunction to prohibit the defendant from working for a competing company.

In granting the employer the primary injunction it sought, the court held, “In Texas, injury resulting from the breach of non-compete covenants is the epitome of irreparable injury.” The court then cited Texas cases holding, “An employee who possesses trade secrets belonging to a former employer accepts employment with one of its competitors, even if acting in good faith, will have difficulty preventing his knowledge from infiltrating his work.” The court added: “Thus, the courts have recognized the need for injunctive relief in these situations.”

The court held that a second justification for a preliminary injunction was that the employee “has been using Daily’s confidential, proprietary and/or trade secret information unlawfully to compete against Daily, and is sharing that information with Daily’s competitors in violation of the [noncompete and nondisclosure agreement].”

In this case, the defendant allegedly engaged in some egregious conduct (unauthorized use and disclosure of confidential information, breach of fiduciary duty, etc.). This conduct alone would have justified the court in granting the employer’s request for preliminary injunction. However, rather than base the injunction upon this conduct, the court based it in part upon the employee’s mere violation of the noncompete agreement. This case is yet another reminder that the tide has turned in Texas against defendants in these cases.