Dallas Non-compete Lawyer : Non-compete Agreements Texas : Non-compete Contract

I am frequently asked by employees about whether their covenants not to compete are enforceable, given that they had no choice but to sign them.  Often, an employer will say to a newly-hired employee, "You need to sign this covenant not to compete if you want to continue working here."  If the employee does so, can he or she later argue that the employer really didn't allow the employee to make a free choice?

Quite frankly, this is likely to be a difficult argument to make in Texas.  There is very little case law on this point.  However, the notion that an employee can avoid a covenant not to compete because it was signed under duress (or because it is what the courts sometimes call an "adhesion contract") may not be very viable here.

Over and over, Texas courts have affirmed the enforceability of noncompete agreements.  Most of these agreements are required by the employer to be signed, if the employee wishes to continue employment.  Based upon Texas case law as it exists today, there is little reason for optimism that a Texas court would invalidate a covenant not to compete because the employer made signing the covenant a condition of continued employment.  Of course, in a particular case the court might do so, but it is probably an uphill battle.

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Not infrequently, an employee who has signed a covenant not to compete will confidently explain to me that, "Noncompete agreements are not enforceable in Texas, because Texas is a 'right to work' state."  Often, the employee's conviction has been confirmed by a family member or friend, and sometimes even by a lawyer who should know better.

The truth is, Texas is a right to work state.  However, "right to work" means that a person can work in Texas without having to belong to a labor union.  It has absolutely nothing to do with the enforceability of noncompete agreements.

As is pointed out throughout this blog, Texas courts in recent years have become increasingly pro--enforcement when it comes to covenants not to compete.  The test for the enforceability of a noncompete agreement (i.e., that the covenant not to compete be "ancillary to an otherwise enforceable agreement") has lost much of its meaning in recent years.  Thus, not only does the fact that Texas is a right to work state not insulate from liability a person who has signed a covenant not to compete, the legal landscape in Texas with respect to noncompete agreements is more dangerous than ever for employees.

So, the next time someone tells you that because Texas is a right to work state, you have nothing to fear from the noncompete agreement that you signed, you need a second opinion.

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Frequently in cases involving noncompete agreements, the issue arises as to whether an overly broad covenant not to compete will be held to be completely unenforceable, or whether it will be modified to make it enforceable.  In some states, if a noncompetition agreement is overly broad, the entire agreement will be unenforceable.  In other states, in response to an overly broad covenant not to compete, the court will engage in what is known as "blue penciling," which means that the court will draw a line through the offending portions of the agreement and enforce whatever remains.

In Texas, if a covenant is overly broad, the court will simply not throw it in the garbage can.  Moreover, Texas courts are not confined to merely striking through offending portions.  Rather, in response to an overly broad covenant not to compete, a Texas court will judicially reform the agreement to make it enforceable.

Thus, if a noncompete agreement contained no geographic restriction, there is a good chance that a Texas court would add a geographic restriction (the court might, for example, hold that the proper geographic restriction consisted of every state in which the employee worked for the employer). Conversely, in a strict blue-pencil-only state, a court would not add a geographic restriction; rather, the lack of any geographic restriction might result in the entire agreement being voided.

Below is a link to a website which attempts to give a state-by-state summary of how courts deal with overly broad covenants not to compete.  I certainly have not confirmed the accuracy of the information contained in this website, and it seems to have been drafted in 2009.  Nevertheless, it might be a useful resource for you.

http://www.non-competes.com/2009/01/quick-state-by-state-guide-on-blue.html

 

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In his excellent concurrence in the Marsh USA case, Texas Supreme Court Justice Don Willett observed something that practitioners and trial court judges often forget or gloss over, namely, the adverse effect that unfair noncompete agreements can have on society at large.   Justice Willett noted:

“Restrictive covenants are not costless, and even a mutually acceptable noncompete can impose a deadweight loss on broader society. Courts should not confuse a noncompete's impact on the employee with its impact on competition. A restraint may be perfectly agreeable to both parties today but still harm consumers tomorrow. . . . It remains the job of courts to be vigilant for practices that tend to servility, that deprive the public of desired services, and that quash rivals the enforced restriction rather than forceful competition.”

He continued:

“Noncompetes tailored to protectable business interests have their lawful place, but they should be used sparingly and drafted narrowly.   And employers must demonstrate special fax that legitimized the noncompete agreement. Squelching competition for its own sake is an enemy unworthy of protection. Competition by a former employee may well rile an employer, but companies do not have free reign to, by contract, indenture an employee or dampen everyday competition that benefits Texas and Texans.”

Obviously, noncompete agreements that serve legitimate interests are enforceable in Texas, as the Texas Supreme Court has confirmed on several occasions, most recently in the Marsh USA case itself.  Justice Willett urges trial courts to ensure that covenants not to compete are fair and reasonable, including from a societal standpoint.

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Justice Don Willett's concurrence in the Marsh USA contains a lot of economic theory and literary allusions that one typically does not see in a court opinion. For example, Justice Willett has this advice for trial court judges who handle disputes involving restrictive covenants in Texas:

“Restrictions on employee mobility that exist only to squelch competition are per se illegal in Texas, and for good reason. Economic dynamism in the 21^st century require speed, knowledge, and innovation-- imperatives that must inform judicial review of efforts to sideline skilled talent. Courts must critically examine non-competes in light of our contemporary, knowledge-based economy that prices ingenuity and intellectual talent. This much is clear: Courts cannot countenance covenants to contemptuous of competition.”

With respect to the primary issue in the Marsh USA case—i.e., whether a Texas covenant not to compete could be justified by the employer's professed need to protect its goodwill, Justice Willett had this to say:

“[U]ttering the word goodwill is not enough; magic words do not boast auto-enforceability. Marsh must demonstrate that it is not invoking goodwill to camouflage a less noble interest: escaping future competition from Cook. . . . More to the point, while 'goodwill' is a bona fide business interest under the Act, it is not enough merely to monitor the word. You cannot simply by a covenant not to compete.”

Justice Willett continued:  

“Judges must divine when competition becomes unfair competition and when a restraint becomes an unreasonable or unnecessarily restrictive restraint. To be sure, the standard has a certain eye-of-the-beholder flavor—a vagueness that inexorably produces the case-by-case unpredictability that haunts this area of employment law.”

Justice Willett notes that the noncompete statute requires that restrictions be both “reasonable,” and that they “not impose a greater restraint than is necessary.” Justice Willett questions whether these are separate requirements. In other words, must a restriction be both reasonable in the abstract sense and also narrowly tailored to be no more restrictive than what the particular employer needs? Justice Willett observes that, “Many courts implicitly subsume everything under an overarching banner of reasonableness, while others treat them as separate prongs.” “Either way,” he says, “this is a question the Texas Supreme Court does not reach”him him in Marsh USA.

Justice Willett cautions trial courts to realize that they “must strike down restrictions that are unreasonable or more severe than necessary.” He explains why:

“The Lone Star State lauds economic dynamism. And while it is perhaps natural for a profit-maximizing company to bend toward collusive or monopolistic restriction, Texas law is hostile to such noncompetitive impulses. Nor can it be doubted that some companies try to tilt the playing field via dubious noncompete covenants, even facially unenforceable ones, knowing that even the specter of enforcement action will chill employees (and their potential employers) into preemptive capitulation.”

He continues:

“A court cannot uphold a noncompete on goodwill grounds absent a record that demonstrates the limitations are reasonable and is not burdensome as possible. Every company has customer relationships and attended goodwill it wants to cultivate by incentivizing employees to stay, but merely asserting goodwill is not enough. . . . The evidentiary record must demonstrate special circumstances beyond the bruises of ordinary competition such that, absent the covenant, [the employee] would possess a grossly unfair competitive advantage. And even then the restrictions imposed must be as light as possible and not restrict [the employee's] mobility to an extent greater than [the employer's] legitimate need.”

Justice Willett wrote a great concurring opinion in Marsh USA.   It should be read by all Texas trial court judges who work in this area.  His opinion suggests that practitioners who believe that "noncompete law is dead in Texas," and that "noncompete agreements are per se enforceable in Texas" may have spoken too soon.  Justice Willett reminds us that trial courts have an important duty to ensure that the agreements sought to be enforced in their courts are reasonable and necessary.

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I re-read (again) the Marsh USA case this morning, including the concurring and dissenting opinions. The concurring opinion by Justice Willett is one of the most articulate and thoughtful opinions I have read in a long time. He tries to strike a balance between the pro-enforcement majority opinion and the dissenting opinion which fears that the majority has gone too far in stifling competition. Justice Willett's opinion should be required reading for every Texas trial court judge who hears disputes involving covenants not to compete.

The majority opinion quotes this language from a 1947 Texas Supreme Court case: “A person's right to use his own labor in any lawful employment is . . . one of the first and highest of civil rights.”

The Court then reminds us: “The Texas Constitution protects the freedom to contract.”

How are these potentially conflicting values to be reconciled? On the one hand, Texas presumably favors the right of a person to work where he wishes. On the other hand, Texas favors the right of that same person to contract away his right to do so. The various opinions handed down in the Marsh USA case depict a philosophical war going on at the Texas Supreme Court. It is not simply a legal dispute. Rather, it is a dispute over the type of economy we want to have in Texas.

Do we, for example, want an economy in which virtually everyone (other than lawyers, of course) is bound to a restrictive covenant? Or, do we expect courts to closely scrutinize these agreements so that only competition which is “unfair” is prohibited?

Unfortunately, although the Marsh USA case unambiguously informs us that the Texas Supreme Court is wary of disputes involving non-compete agreements, and that it has decided to adopt a far more pro-enforcement position, there are many unanswered questions. As the dissent notes, if protecting goodwill is an interest that can support a covenant not to compete, what happens to the long-standing rule in Texas that an employer cannot simply “buy” a noncompete agreement? Is it now the case that a Texas employer can simply give an employee a raise, or a signing bonus, or a promotion, or even continued employment, and have an enforceable covenant not to compete? After all, wouldn't providing these to an employee might motivate the employee to develop goodwill for the employer.

Perhaps recognizing the possibility that its opinion might be interpreted too broadly, the majority in Marsh USA emphasizes that the employee was an “owner” and “managing director” of the company, and that he was a “valuable employee who had successfully performed at his position . . . and had been successful with attracting and retaining business for Marsh.” In other words, the Court may be saying, the rule we hand down today may not be as expansive and pro-enforcement as it appears to be.

All we know for sure is that the continued viability of any portion of the Light case decided in 1994 is dubious at best. As practitioners in this area know, the Court in Light imposed a two-part test to determine whether a covenant not to compete was “ancillary” to an “otherwise enforceable agreement.” The court in Marsh USA goes to great lengths to explain why the Light Court misinterpreted the meaning of “ancillary.” In doing so, Marsh USA does away with, or at least significantly changes, the “give rise” requirement. The opinion does not seem to explicitly abolish the second prong of the Light test (i.e., that the covenant be designed to enforce the employee's “reciprocal” promise contained in the otherwise enforceable agreement), but it arguably impliedly done so, because the Court calls into question Light's entire definition of “ancillary.”

Obviously, for laypeople, this post is, as the Texas Supreme Court might say, “overly technical.” The bottom line is, the pendulum has definitely swung in Texas. Employees who are bound by noncompete agreements in Texas have much to be concerned about.

Happy New Year.

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Texas cases dealing with the enforceability of noncompete agreements have long held that “industry-wide” restrictions are overly broad. In a recent case from the Waco Court of Appeals, the court applied that rule to a concrete situation.

The covenant not to compete applied to the “pet supply manufacturing and distribution industry.” The employee contended that this restriction was so broad as to constitute an invalid industry-wide exclusion. The court of appeals disagreed, holding: “[B]ased on the terms of the Agreement, [the employee] would not be precluded from working as a dog handler and groomer, as he did prior to being employed by [the employer]. We conclude that the terms of the Agreement do not amount to an industry-wide employment exclusion and are not unreasonably broad in scope of activity.”

The prohibition against industry-wide exclusions is well known. This case sheds a little light on what would not constitute such a restriction.

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 The Marsh USA case was perhaps the most important non-compete case coming out of the Texas Supreme Court since the Light case in 1994. And that's saying a lot, given the Sheshunoff (2006) and Mann Frankfort (2009) opinions which made non-competes more enforceable in Texas.

After Marsh USA, Texas restrictive covenant attorneys will have to monitor decisions coming from the Texas Court of Appeals to see whether the pro-enforcement trend continues. A recent case from the Waco Court of Appeals suggests that Texas courts will continue to look with favor upon covenants not to compete.

In the case out of Waco, the court upheld a customer solicitation provision prohibiting the employee from “directly or indirectly interfer[ing] with, or endeavor[ing] to entice away from the Company any clients or account with whom the Employee had direct contact at any time during his or her employment at Company, or for or with any other person, firm, corporation, partnership, joint venture, association, or other entity whatsoever, which is or intends to be engaged in providing or manufacturing pet supplies and related products manufactured and distributed by Company.” In upholding this provision, the court noted that, “Courts have upheld similar provisions prohibiting a former employee from soliciting the employer's customers or disclosing the employer's confidential information.”

The court also addressed the employee's contention that the noncompete agreement contained no geographic limitation. The court noted the Texas rule that “limiting the applicability of the covenant to particular client bases is an acceptable substitute for a geographic limitation in a noncompete agreement.”

Finally, the court held that a five-year restraint was not unreasonable. The court noted that Texas courts have held that restraints of two to five years can be reasonable.

Yet again, a Texas court has come down squarely in favor of enforcing covenants not to compete. This appears to be the first reported case handed down since the Marsh USA decision. Texas courts seem to be accepting that we live in a legal environment that is much friendlier to non-competes than the one in which we lived just a few years ago. Employees who are bound by non-compete agreements in Texas must be wary of this trend.

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Often in litigation involving noncompete agreeents, an employee bound by a noncompete agreement will contend that the scope of the restrictions contained in the agreement are overly broad. The employee may, for example, argue that an agreement prohibiting customer solicitation is too broad. Or, an employee may argue that a covenant not to compete is too restrictive; e.g., the employee may allege that the restrictions last too many months or years, or that the geographic restrictions are unreasonable.

A recent Texas appellate case concerned a noncompete agreement that contained no geographic restriction. Rather, the agreement stated that the employee would “not work for a competing third party for the term of one year.” The agreement further stated that the employee would “not start a publication outside of [his employer] for a term of one year.”

The Texas appeals court refused to invalidate the agreement. Instead, the court—although it found that the agreement was “overbroad and unenforceable”—reformed the agreement. The court noted that the Texas noncompete statute requires a court to “reform . . . [an overly broad] covenant to the extent necessary to cause the limitations to be reasonable and to impose a restraint that is not greater than necessary to protect the goodwill or other business interest of the promisee and enforce the covenant as reformed.”

In this case, rather than invalidating the covenant because it contained no geographic limitation, the court reformed the agreement to prevent the employee from competing in the same territory in which he worked while he was with his former employer. While with his former employer, the employee had been a salesperson in Johnson County; the appellate court held that the employee could be prohibited from competing there.

However, the court refused to preclude the employee from competing in areas into which his former employee had planned to expand. The court held that such a restriction would be unreasonable.

The takeaway from this case is: Don't assume that just because a noncompete is too broad, a court is likely to invalidate it. Texas courts often reform overly broad noncompete covenants by making them reasonable.

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