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

"Others in the company were not is required to sign covenants not to compete.  Does that mean that my covenant is not valid?"

I get this question a lot.  The short answer is, No, the fact that the employer did not require all of its employees to sign noncompete agreements does not, by itself, mean that the restrictive covenant signed by a particular Texas employee is unenforceable.

That said, an employer's failure to have all of its employees sign noncompete agreements (or, at the very least, nondisclosure agreements) might be relevant to the enforceability of a particular noncompete agreement.  It would all depend upon the facts of the case. 

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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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The Marsh USA decision, which was handed down by the Texas Supreme Court earlier this month, sent shock waves through the community of lawyers who handle matters involving noncompete agreements.  The decision creates danger for employees bound by noncompete agreements here.  Hopefully, the word about this and other pro-enforcement decisions will get out, so that laypeople can stop referring to Texas as a "right to work" state.

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 The Texas Supreme Court's long-awaited opinion in the Marsh USA case was released on June 24, 2011. As readers of this blog know, in recent years, Texas has gone from being a very anti-noncompete-agreement state to a relatively pro-enforcement state. In the Sheshunoff and Mann Frankfort cases, the court had eliminated arguments that employees had previously used to defeat covenants not to compete in Texas. By accepting the Marsh USA case for review, the Supreme Court suggested that it might further restrict anti-enforcement arguments. And indeed it did.

Prior to Marsh USA, Texas courts had consistently held that in the employment context (as opposed to the sale of a business context), the only consideration that would justify a restrictive covenant was the employer's providing of confidential information and specialized training. Texas appellate courts had held that an employer's giving of money to an employee was insufficient to justify a noncompete agreement.

Thus, giving an employee a signing bonus when he signed the no compete agreement, or having him sign the covenant in conjunction with receiving a promotion was not enough. Rather, to have an enforceable noncompete agreement, a Texas employer had to provide its employees with trade secrets, confidential information, or specialized training.

The issue in Marsh USA was whether an employer who had given stock options to its employee could enforce a noncompete agreement against him. The Texas Supreme Court held in the affirmative.

We will have several more blog posts on this important case and its implications. But the main take away from the case is this: The Texas legal landscape pertaining to noncompete agreements is constantly evolving (or devolving, depending upon your point of view). The bottom line is, covenants not to compete are far more enforceable in Texas now than they were just a few years ago. As a result of the holding in Marsh USA, monetary compensation (at least in the form of company stock) may be sufficient to support an employee's noncompete obligations. This is a major change in Texas employment law.

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Texas courts continue to confirm the enforceability of some noncompete agreements here.  I routinely here from people that "Texas is a right to work state, and noncompete agreements are not enforceable here."  Five years ago, Texas courts were extremely unsympathetic to noncompete agreements.  But ever since the Sheshunoff and Mann Frankfort cases were decided, Texas courts have been more willing to enforce restrictive covenants against employees.

A recent case from the federal Northern District of Texas proves this point.  There, the employee was trained on the employer's "processes and requirements."  "She also became familiar" with the employer's "price schedule" for one of its customer contracts.  This kind of confidential information is routinely conveyed by employers to employees.

After the employee resigned, became employed by a competitor, and began doing work for one of her ex-employer's customers, her former employer sued her for violating her noncompete agreement.

The court enforced the agreement, based upon the confidential information that was conveyed.  In doing so, the court noted, "Two to five years has repeatedly been held as a reasonable time limitation, and the restraint here only lasts six months.  And Texas courts have upheld geographical limitations preventing competition within a metropolitan area, as the 50-mile limitation essentially does here."

OBSERVATION:

Once again, a Texas court dispels the "right to work" myth.  In Texas, noncompete agreements can indeed be enforceable. 

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A recent case from the Beaumont Court of Appeals highlighted the difficulty that employers sometimes face in enforcing noncompete agreements in Texas.  In this case, a physician practice group sued one of its former physicians for violating a noncompete agreement.  The physician had left the practice and started his own practice within the proscribed 22-mile radius.  The trial court denied the practice's request for a temporary injunction.

The court of appeals affirmed.  In doing so, the court emphasized that when the noncompete was signed, and the 22-mile radius agreed to, the population of the city in question was roughly half what it was years later when the practice sought to enforce the covenant.  The court also noted that the practice had failed to prove that the physician had disseminated any of the practice's confidential information, or that the practice had suffered a loss of revenue due to the physician's actions.  In short, the practice had failed to prove irreparable harm--which is a prerequisite to obtaining a temporary injunction in Texas.

OBSERVATION:

The court also noted that the result at the final trial might be very different.  At the permanent injunction stage, the employer need not prove irreparable harm.

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The Fort Worth Court of Appeals recently issued a very interesting opinion on the geographic scope of noncompete agreements in Texas.  In this case, a publishing company did business in Johnson County, Texas.  The company hired the defendant to sell advertising for it.  The defendant's job duties were performed in Johnson County.

The defendant resigned and began competing in nearby Parker County.  The company sued him for violating his noncompete agreement.  The company contended, "We were planning on expanding into Parker County, and you knew that.  Thus, you should not be allowed to compete with us there."

The Fort Worth Court of Appeals rejected the company's argument.  In doing so, the court noted Texas' long-standing rule that the proper scope of a noncompete agreement is the territory in which the employee worked.  The court noted, "The parties have not cited, and we have not found, a case in which a geographical limitation including areas where an employer does not currently operated but has targeted for futur expansion, standing alone, is reasonable."

The court of appeals reversed the trial court's ruling in favor of the company.

OBSERVATION:

When analyzing the proper scope of a noncompete agreement, Texas courts usually focus primarily upon the activites of the person bound by the covenant.  In this case, the company tried to expand the scope of the covenant to counties in which it planned to do business.  But the court of appeals held that this went too far.

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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.

www.felllawfirm.com

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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.

www.felllawfirm.com

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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).

 www.felllawfirm.com

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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.

www.felllawfirm.com

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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.

www.felllawfirm.com

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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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 “Texas is a right to work state--non-compete agreements are unenforceable here.”

You’ve heard that 100 times, right?  I know I have.

And it is dead wrong.  The fact that Texas is a “right to work” state means that Texas employees can’t be forced to join a union.  It has nothing to do with whether non-compete agreements are enforceable.

In fact, non-compete agreements are enforceable in Texas if they are (a) supported by adequate consideration and (b) reasonable in scope.  These concepts are discussed in this blog.

So, the next time someone guarantees you that your non-compete agreement is unenforceable because “Texas is a right to work state,” don’t believe them!

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A recurring issue in Texas law is whether financial compensation can constitute sufficient consideration for a non-compete agreement.  This issue came up recently in a case from the Dallas Court of Appeals.

In that case, a company that provided insurance brokerage services granted some stock options to one of its managing directors.  The options were conveyed in an Employee Incentive and Stock Award Plan.  However, before exercising the options, the employee had to sign a non-compete agreement.

After the employee exercised his stock options, he terminated his employment.  Shortly thereafter, he began working for a competitor, at which point a lawsuit was filed to enforce the non-compete agreement.

The trial court held that the non-compete agreement was unenforceable, and the court of appeals affirmed. In doing so, the court explained, “The most common types of consideration given in return for a covenant not to compete are a company’s trade secrets or other confidential information.  A company’s goodwill is dependent, in part, in keeping such information confidential.  Financial benefits, on the other hand, do not give rise to an interest worthy of protection.”

The company contended that offering stock options to a valuable employee also gave rise to its interest in protecting its goodwill.  The court of appeals rejected this argument:

Texas requires that the consideration provided by the employer give rise to the company’s interest in restraining competition. . . .

All companies have an interest in retaining good employees. Stock options are frequently utilized in an effort to retain valuable employees. . . . However, the fact that a company’s business goodwill benefits when an employee accepts the offered incentive and continues his employment does not mean that the incentive gives rise to an employer’s interest in restraining the employee from competing. . . .

The court also explained that the “give rise” requirement can be met “only if the consideration given by the company creates the interest in restraining competition.”  Conveying stock options, the court held, could not meet this requirement.

Conclusion:  Several Texas cases have questioned whether financial incentives could serve as the basis for an enforceable non-compete agreement.  Perhaps more than any other case, this case rejects the notion that financial compensation, such as the granting of stock options, can constitute adequate consideration for a non-compete agreement in Texas.

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In Texas, non-compete agreements that arise from the sale of a business are relatively more enforceable than those that are contained in an employment agreement.  For example, Texas courts have held that covenants not to compete may be significantly broader in scope if they arise from the sale of a business.  However, as a recent case demonstrates, from the buyer’s point of view, getting an enforceable non-compete agreement can sometimes be more difficult than it appears.

In the case, two men, Sledge and Armour, purchased some oil drilling rigs from a West Texas oil company (Bandera Drilling).  The purchase price was approximately $34 million. 

The purchase agreement was signed by the buyers, Bandera Drilling, and Bandera Drilling’s individual owner (Brazzel).  The agreement contained a covenant not to compete which prohibited both Bandera Drilling and Brazzel from competing with the buyers for five years.

After the agreement was signed, Bandera Drilling’s employees were introduced to Sledge and Armour as the new owners.  Bandera Drilling’s rig hands went to work for Sledge and Armour, and Bandera Drilling transferred some of those employees’ employment files to Sledge and Armour so that the employees could have health insurance.  Moreover, Bandera Drilling’s salesman introduced Sledge and Armour to Bandera Drilling’s customers.

Shortly thereafter, Brazzel began competing with Sledge and Armour in West Texas.  Sledge and Armour filed suit to enforce the non-compete agreement.  The trial court enforced the non-compete agreement (after reforming its geographic scope), but the court of appeals reversed.

On appeal, Brazzel characterized the transaction as a simple of purchase of assets (“the naked purchase of rigs and equipment”).  Brazeel contended that because Sledge and Armour only purchased assets—oil rigs—and not goodwill, the non-compete agreement was not supported by adequate consideration.

In assessing the enforceability of the non-compete agreement, the court believed it significant that, after the purchase agreement was signed by the parties, Bandera Drilling (a) introduced Sledge and Armour to its employees as the new owners, (b) gave Sledge and Armour information from the employees’ personnel files; and (c) introduced Sledge and Armour to Bandera Drilling’s customers.  As the court noted, “These [customer] introductions undercut Bandera Drilling’s future competitiveness in West Texas because they encouraged customers to transition to another drilling company.”  These factors could lead to the conclusion that Sledge and Armour purchased not just oil rigs, but the business as a whole, including the goodwill. Purchase of the goodwill would justify a promise not to compete.

After listing these factors, though, the court concluded that the non-compete covenant was unenforceable.  The court based its decision on the following:

Even though Bandera Drilling did introduce its customers to Sledge and Armour, it was not contractually obligated to do so.  It was also not contractually obligated to facilitate the transition of its employees to Sledge Drilling.  Because the contract did not obligate Bandera Drilling to take such actions, the contract could not be said to have involved the purchase by Sledge and Armour of Bandera Drilling’s goodwill.  Rather, the contract merely involved a sale of assets—oil rigs—and such sale could not justify a non-compete agreement.

The takeaway from this case is that if a buyer wants to have an enforceable non-compete agreement, it needs to purchase the seller’s goodwill, not just his assets.  If I start a restaurant and buy some used tables and bar stools from a competitor, that will not justify a promise by my competitor not to compete.  However, if I buy his entire business, including the goodwill that he has established in the community over several years, that will justify a covenant not to compete.  In this case, the buyers just bought assets, not goodwill, and thus did not have an enforceable non-compete agreement.

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 Texas courts have long held that an employer’s providing of confidential information can constitute sufficient consideration for a non-compete agreement.  But it can be difficult to apply this widely accepted premise, as was demonstrated in a recent case.

In the case, an insurance broker signed an employment agreement in which he acknowledged that he would receive confidential information:

This information (hereinafter referred to as “Confidential Information”) includes, but is not limited to, data relating to AJG and the Corporation’s unique marketing and servicing programs, procedures and techniques; the criteria and formulae used by AJG and the Corporation in pricing its insurance and employee benefits products and claims management, loss control and information management services; the structure and pricing of special insurances packages that AJG and the Corporation have negotiated with various underwriters; lists of prospects compiled by AJG and the Corporation’s management and research staff; the identity, authority and responsibilities of key contacts at AJG and the Corporation accounts, including accounts of the Acquired Business; the composition and organization of accounts’ businesses; the peculiar risks inherent in their operations, highly sensitive details concerning the structure, conditions and extent of their existing insurance coverages; policy expiration dates; premium amounts; commission rates; risk management service arrangements; loss histories; and other data showing the particularized insurance requirements and preferences of the accounts. The Executive recognizes that this Confidential Information constitutes a valuable property of the Corporation, developed over a long period of time and at substantial expense.

As can be seen from this provision, the broker was to receive various types of confidential information: confidential client contact information, pricing information, customer preference information, information concerning the customers’ policies, etc.  The broker contended that much of this information was not confidential, because it could be obtained from public sources.

The company disagreed, and argued that its confidential information (a) took years to acquire; (b) was only shared with the company’s employees and agents on a “need to know” basis; (c) was not “readily ascertainable by competitors”; and (d) gave the company a “valuable competitive advantage in the insurance brokerage industry.”  The company also contended that it spent substantial resources developing and acquiring the information, and that it took reasonable precautions to prevent the disclosure of the confidential information.

The court agreed with the company.  In doing so, it found as persuasive the fact that the company had spent substantial time and resources developing and acquiring the information, it had taken reasonable precautions to prevent disclosure of the information to third parties, the information was not readily available to competitors, and the information gave the company a valuable competitive advantage in the industry.  Based upon these factors, the court held that the confidential information was sufficient to make the non-solicitation agreement enforceable.

Interestingly, the dissenting opinion disagreed that the information was sufficiently confidential.  The dissenting judge explained:

Just because it took GHIS years to acquire and compile information about its customers and it shared this information with employees and agents of GHIS only on a “need to know basis” does not make the information “protectable.” Nor does the fact that the compilation of the information somehow gives GHIS a competitive advantage make the information “protectable.”

The critically important fact remains that GHIS has not demonstrated that the identity of its customers and the information about its customers cannot readily obtained by others outside of GHIS. Nor has GHIS demonstrated that the information about its customers cannot be ascertained simply by inquiry addressed to the customers themselves.

From the majority and dissenting opinions in this case, we can see that different judges can look at the same set of facts and reach completely different conclusions.  For that reason, it is difficult to predict with certainty how a particular dispute involving a non-compete agreement will be decided in court.

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In determining whether a non-compete agreement is enforceable, a Texas court will assess whether the consideration given by the employer justifies the non-compete agreement.  Texas courts have held on multiple occasions that an employer’s providing of confidential information is sufficient consideration for a non-compete agreement.

Even without an enforceable non-compete agreement, a Texas employer has legal rights and remedies in the event one of its current or former employees is using or disclosing its “trade secrets.”  Possible claims for such conduct include misappropriation of trade secrets and breach of fiduciary duty.

But what is the relationship between “confidential information,” which is sufficient consideration for a non-compete agreement, and “trade secrets,” which is a tort concept?  Texas case law on this point is not clear.

For example, in a recent appellate case, the court, in examining whether the employer had an “interest worthy of protection” sufficient to justify the non-compete agreement that its former employee had signed, first noted that a “trade secret” may “consist of any formula, pattern, device, or compilation of information that is used in one’s business and which gives one an opportunity to obtain an advantage over competitors who do not know or use it.”  The court noted that certain types of customer information, business plans, etc., could, under appropriate circumstances, constitute trade secrets.

However, the court then seemed to distinguish trade secrets from confidential information, stating that a “covenant not to compete is enforceable not only to protect trade secrets but also to protect proprietary and confidential information.”  Thus, “trade secrets” and ”confidential information,” although often used interchangeably in cases dealing with non-compete agreements, do not seem to be synonymous.  Employers may be able to bind their employees to non-compete agreements by providing information which, though confidential, does not rise to the level of a trade secret.

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In our practice, we see many disputes between doctors and their employers from both sides of the fence.  Quite often these disputes are between practices or institutions and doctors who are just “hitting their stride,” developing loyal patients and looking at their practice options for the future.  At that point, both parties search for the contract they signed and put in a drawer a few years earlier and begin examining its arcane phrases with a scanning electron microscope.

The eventual terms of any agreement between a doctor and his or her employer depend on many factors, including the respective bargaining power of the parties.  We thought it would be helpful for you to have a road map of the terms you are likely to encounter in your first agreement.

Like any document prepared by a lawyer, there is some fine print at the end.  In the meantime, give some thought to these items (which by no means exhaust the important provisions of an employment agreement) before you make your first commitment as an employee:

How Long.   What is the duration – called the “term” –  of the contract?  This is the duration of your employer’s commitment to you, and yours to your employer.   Is it long enough to allow you to establish your practice?  Is it so long that you would be unfairly stuck with a fixed compensation structure while your practice grew?   Does the contract automatically renew at the end of the initial term and keep renewing (usually for a year at a time) unless one side cancels with notice (called an “evergreen clause”) – which can be both good or bad, depending on how the contract handles it?

How Much.   How is your compensation set?  Is it tied to performance?   If so, does the contract fairly allow you some influence on your performance goals and your employer’s support in meeting them?   This tends to be a business term heavily influenced by market factors, but you still need to ensure that your future employer gives you a fair shot to maximize your income. 

Review incentive compensation and bonuses.  When are they paid?  What offsets will the practice take for expenses (such as technicians and nursing staff)?  If you leave before you receive a bonus, are you entitled to a pro rata share of the bonus or incentive compensation?

Out-of-Pocket (or Purse).    You will have a lot of expenses.   Most employers pay or reimburse the basics, but consider some unusual expenses, such as costs associated with providing services at multiple locations, and don’t forget necessary certifications and continuing medical education.  Don’t assume that your employer will pay all expenses of you being a doctor – get it clear up front.

Vacation.   Is there a paid vacation policy?  What if you can't or don't choose to take all your paid vacation?  Will the days roll over to the next year, or can you cash out your unused days?

Sick Leave/Personal Time.    What does your employer provide if you are temporarily disabled due to injury or illness?  Does the agreement define the term "disability”?  If you are disabled, how long will you receive your base compensation?  If you have minimum collection requirements in your contract, can this be adjusted to take into consideration a decrease in productivity due to a temporary disability?

On Call Obligations.   Are your “on call” coverage obligations clearly spelled out?  Is call limited to specified locations?

If Your Contract Doesn't’t Go to Term.   Yes, it happens. That great relationship at the outset of your employment can sour for a multitude of unforeseeable reasons.  What are the conditions permitting either you or your employer to terminate the agreement before the end of its term?   The procedures are critical here.  This is a major source of litigation, as are: 

Noncompetition Agreements.  The hands-down winner in the I-guess-I-need-to-call-a-lawyer sweepstakes is the famous “covenant not to compete” provision, sometimes shortened to “noncompete.”  This is a provision that limits (but does not entirely prohibit) an employee’s ability to work elsewhere after the employment ends or is terminated.  Some doctors are under the misimpression that these provisions are not enforceable in Texas because they are anticompetitive.  Not true.  It is true that there are special conditions imposed upon them in Texas, but if those conditions are met, courts will enforce contract provisions that keep you from practicing within a certain geographical area for a certain period of time after your employment ends.  The good news is that there are ways to limit the effect of such provisions. 

Partnership.    If your employer is a medical practice, consider requiring a commitment on its part to consider you for partnership (or whatever form of ownership the practice uses) after a certain period of time.

Your Patients’ Records.   Your contract may end or your contract may be terminated prematurely.  Either way, if you have your own patients you are going to want their records.   You need to provide for that in the agreement.

The More Things Change.   With federal law and regulation changing rapidly with respect to matters such as recordkeeping, reimbursement, and even compensation itself, employers have begun inserting provisions permitting them to make unilateral changes to the contract to keep it in compliance with law.  Sounds reasonable, but you should have notice of the change and the opportunity for input (or the option to bail out).

Malpractice Insurance.  Yes, your employer will provide it, but it’s more complicated than that – what happens when your employment is over?  This issue is of particular importance with respect to your second employer and something called tail insurance.  Big-dollar item.

Dispute Resolution.  If you have a dispute over the terms of the employment agreement, how will it be resolved?   Frequently (and, in the case of hospitals, almost always) employment agreements provide for mandatory arbitration (that is, the parties cannot go to court; the dispute is heard by a non-judge with no jury).  Does the contract provide that both sides must conduct a face-to-face meeting before initiating legal proceedings?   Is there a provision requiring the loser to pay legal fees, and, if so, which side does it favor?

Two Sides to Every Story. We have focused here on things that the new doctor is going to want. Your employer is going to want some things, too, and it’s going to insist on them:   Getting and keeping your license; maintaining your privileges at hospitals; abiding by the rules and regulations of the practice or institution; complying with legal requirements; and many more.  Still, you want to make sure your employer doesn’t slip in anything unreasonable, or phrases it in such a way that it turns out to be at “gotcha” at some later date.

As noted, this list only hits the highlights. There are many other possible provisions the new employee should carefully heed.

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The Texas Supreme Court recently made it even easier to enforce noncompete agreements.  Ever since the court’s opinion in the Sheshunoff case, it has been an open question whether, to be enforceable, a noncompete agreement must contain an explicit promise by the employer to provide confidential information to the employee.  In Mann Frankfort Stein & Lipp Advisors, Inc. v. Fielding, 52 Tex. Sup. J. 616 (Tex. April 17, 2009), the court answered this question, and held that the employer’s promise to do so can sometimes be implied.

In Mann, the court held that even if the noncompete agreement does not contain an explicit promise by the employer to provide confidential information, if the employee’s job will reasonably require the employer to do so, then an implied promise to provide confidential information exists.  This implied promise will provide the consideration necessary to make the noncompete agreement enforceable.

This is an important holding, obviously, because it means that some noncompete agreements that were previously thought to be enforceable, now arguably are.  Of course, the employee bound by the non-compete agreement will still be able to challenge whether the information given to him was truly confidential, and he also may be able to contend that the scope of the restriction is unreasonable.

Nevertheless, the combined effect of Sheshunoff and Mann suggests that the supreme court may be tiring of “technical” arguments over the enforceability of noncompete agreements.  Rather than constantly focusing on the precise wording of the agreements, and on when the information which arguably justifies the restrictions was conveyed to the employee, the court may be signaling a desire to focus on what it considers to be the true substantive considerations:  whether confidential information was in fact conveyed and, if it was, whether the information justifies the restrictions contained in the agreement.

For employers whose current or former employees are bound by noncompete agreements(particularly if the agreements were signed years ago), this will make enforceable some agreements that otherwise would be unenforceable.

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 A recurring issue in non-compete cases involves how definite the employer's promise to provide confidential information must be for the agreement to be enforceable.  Historically, disputes have focused on whether an explicit promise to provide the information was required, or whether an implied promise (e.g., language in which the employee "acknowledged" that he would receive information) was sufficient. 

In a recent case from the United States Court of Appeals for the Fifth Circuit, the court held that the following combined to make a non-compete agreement enforceable: 

1. A definite term of employment.  The agreement provided that the employee would be employed for three years, and that he could only be terminated for good cause; 
2. A nondisclosure provision.  The employee promised that he would not disclose his employer's confidential information to others; and 
3. Receipt of confidential information (but no promise by the employer to provide any information).  The employee actually received confidential information from the employee. 

Based upon these facts, the court held that the agreement contained an implied promise by the employer to provide confidential information to the employee.  The court explained: "The Employment Agreement indicates that both Stock and Vybiral anticipated that Vybiral would work at Stock for at least three years. . . . Further, the Employment Agreement itself contemplated that Vybiral would be receiving confidential information, as evidenced by the nondisclosure covenant. Finally, the district court found that Vybiral did in fact have access to Stock's confidential information, including sales strategies, marketing strategies, pricing strategies, vendor arrangements, contractor programs, and customer information."

OBSERVATION: 

This opinion, as well as the earlier opinion from the Corpus Christi Court of Appeals (about which we blogged on October 1, 2008), suggests that, in determining whether the wording of a non-compete agreement is enforceable, courts are less willing than ever to invalidate an agreement because certain words (such as "Employer promises to provide Employee with confidential information") are not used.  Rather, courts seem willing to examine an agreement in its totality, to assess whether the parties envisioned that the employer would convey confidential information to the employee.  The lesson of the Texas Supreme Court's Sheshunoff opinion, and subsequent cases, appears to be that courts are putting substance over style in determining the enforceability of non-compete agreements. As a result, non-compete agreements that formerly might not have been enforceable may now be viable. 

Ray Mart Inc. v. Stock Building Supply of Texas LP, et al., No. 07-50609 (5th Cir. Nov. 5, 2008).

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A recent case from the federal court in Dallas sheds some light on various issues involving the enforceability of non-compete agreements.

In Staples, Inc. v. Sandler, No. 3:07-CV-0928-K, 2008 WL 4107656 (N.D. Tex. Aug. 29, 2008), the employee, Sandler, upon joining Staples, Inc., signed a “Proprietary and Confidential Information Agreement” and a separate “Non-Compete and Non-Solicitation Agreement” (“Non-Compete Agreement”).

In the “Recitals” section of the Non-Compete Agreement, the employer recited that it “has and will entrust Employee with proprietary information, strategies, knowledge, customer relationships and know-how which would be detrimental to the Company if disclosed.” The court held that, under Sheshunoff, this recital was a “unilateral contract conditioned upon performance.” The court added: “Further, the confidentiality agreement signed contemporaneously with the noncompete provided a promise of confidential information. Thus, Staples promised to provide Sandler with confidential information that would give rise to its interest in restraining Sadler from competing.”

The court confirmed that the confidential information given by Staples to Sandler was sufficient consideration for the non-compete: “Staples has established that it provided Sandler with access to cost margins, pricing lists, sales figures, and assorted business information, including customer information. Although not necessarily trade secrets of the highest order, these may be confidential in the sense that they are not readily available to the public.”

The restrictions contained in the noncompete agreement prohibited Sandler from doing business not only with Staples’ customers, but also with “customers or prospective customers” that he “knew, serviced, or was familiar with prior to joining the Company."

The court held that this restriction was overly broad:

“Here, it is apparent that the restraint on competition is not justified to the extent contemplated in the covenant not to compete given Sandler's relatively short employment, the minimal amount of confidential information he received, and Staples' legitimate interest in protecting the confidential information it provided him during his tenure. Thus, the Court finds that Staples' legitimate interest in confidentiality gives rise only to a restraint on Sandler that prevents him from competing by doing business with customers he gained during his eleven-month tenure with the company. A restraint that prevents him from continuing long-standing relationships that he brought with him to Staples is overbroad, unrelated to Staples; legitimate interest in confidentiality, and would further unreasonably burden these third-party customers.”

OBSERVATIONS:

1. The court emphasized the need for the employer to promise to convey confidential information. However, the court located part of the promise in a different [but contemporaneously signed] document (the Proprietary and Confidential Information Agreement).
2.  The Court confirmed that confidential information necessary to justify a non-compete agreement does not have to rise to the level of a trade secret. The Court was skeptical of an argument that employers routinely make to prove that their information is confidential (i.e., “The fact that our information is password protected proves it’s confidential”).
3.  The Court found the non-compete restriction overly broad because it applied to customers with whom Sandler worked before he became employed by Staples. It would be interesting to know whether the result might have been different had Staples given Sandler confidential information about these customers. Arguably, if Staples entrusted Sandler with new confidential information (i.e., information that he didn’t previously know) about these customers, the conveying of that information by Staples would have justified the non-compete restrictions.
4.  The Court notes the challenge inherent in binding relatively new employees (11 months, in this case) to non-competes (because they may not yet have been exposed to enough confidential information to justify the restrictions). 

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Almost two years ago, in the Sheshunoff case, the Texas Supreme Court rejected the notion that an employer must provide the employee with confidential information at the precise moment the non-compete agreement is signed for the agreement to be enforceable. According to the court, it is not fatal to the agreement's enforceability if the information is actually provided sometime later.

But how exactly must the agreement be worded for it to be enforceable? A recent case out of the Corpus Christi Court of Appeals addresses that question. In Shoreline Gas, Inc. v. McGaughey, an at-will employee was bound by an agreement that contained promises by the employee (a) not to disclose the employer's confidential information and (b) not to engage in post-employment competition. 

Significantly, the agreement did not obligate the employer to provide confidential information to the employee. Nevertheless, the court found that the employer had in fact provided such information.

The court first held that the non-compete agreement was an enforceable unilateral contract. The court explained:

McGaughey's promise not to disclose Shoreline's confidential information, though not enforceable when made, constituted an offer for a unilateral contract which Shoreline had the option to accept. Shoreline accepted McGaughey's offer by performing—that is, by supplying McGaughey with confidential information—and so a unilateral contract was formed under which McGaughey became bound by his promise not to disclose that information.  . . . Under Sheshunoff, such a unilateral contract constitutes an "otherwise enforceable agreement" sufficient to support an accompanying non-compete covenant.

The court specifically addressed the employee's contention that the agreement was unenforceable because it did not contain a promise by the employer to provide the employee with confidential information:

McGaughey notes that, unlike in the present case, the Sheshunoff employment contract required the employer to provide to the employee with "access to certain confidential and proprietary information and materials belonging to Employer. . . ." Alex Sheshunoff Mgmt. Serv., L.P. v. Johnson, 209 S.W.3d 644, 647 (Tex. 2006). This promise was illusory, however, because the employer could avoid performance simply by terminating employment. Further, this promise was not of the type that could be considered an offer for a unilateral contract that could be accepted by the performance of the promise. Therefore, it could not have formed the basis of an "otherwise enforceable agreement" capable of sustaining a non-compete covenant. See Id. at 650.

Thus, according to the court of appeals in McGaughey, as long as the employer provides confidential information to the employee (even if the agreement does not contain a promise by the employer to do so), a unilateral contract is formed when the employer does so (with the employee's promise not to disclose the information constituting the other part of the unilateral contract). According to the court, this unilateral contract is an otherwise enforceable agreement sufficient to support a promise by the employee not to compete.

This holding should be examined in light of the following passages from Sheshunoff (with emphases supplied): 

If only one promise is illusory, a unilateral contract can still be formed; the non-illusory promise can serve as an offer, which the promisor who made the illusory promise can accept by performance. For example, suppose an employee promises not to disclose an employer's trade secrets and other proprietary information, if the employer gives the employee such specialized training and information during the employee's employment. If the employee merely sought a promise to perform from the employer, such a promise would be illusory because the employer could fire the employee and escape the obligation to perform. If, however, the employer accepts the employee's offer by performing, in other words by providing the training, a unilateral contract is created in which the employee is now bound by the employee's promise. The fact that the employer was not bound to perform because he could have fired the employee is irrelevant; if he has performed, he has accepted the employee's offer and created a binding unilateral contract . . . .

*           *           *

We agree with Light's recitation of basic contract law in footnote six that "[i]f only one promise is illusory, a unilateral contract can still be formed; the non-illusory promise can serve as an offer, which the promisor who made the illusory promise can accept by performance." Upon further review of the Act and its history, however, we disagree with footnote six insofar as it precludes a unilateral contract made enforceable by performance from ever complying with the Act because it was not enforceable at the time it was made.

*           *           *

We now conclude, contrary to Light, that the covenant need only be "ancillary to or part of" the agreement at the time the agreement is made. Accordingly, a unilateral contract formed when the employer performs a promise that was illusory when made can satisfy the requirements of the Act.

*           *           *

But if, as in the pending case, the employer's consideration is provided by performance and becomes non-illusory at that point, and the agreement in issue is otherwise enforceable under the Act, we see no reason to hold that the covenant fails.

A few observations:

1. Sheshunoff addressed a non-compete agreement containing a promise by the employer to provide confidential information to the employee, and the opinion speaks of the employer's "promise"—although the promise was "illusory" when made, because the employee could have been fired in the interim—becoming enforceable upon the information being conveyed. Thus, Sheshunoff can be seen as assuming that the employer must promise to provide the confidential information, even if the promise is "illusory" at the time it is made.
2. The court in McGaughey construes Sheshunoff as only requiring the employer to provide confidential information; the contract need not contain an explicit promise to provide confidential information.
3. Obviously, in drafting new agreements, the safest course remains to include language by which the employer explicitly promises to provide confidential information to the employee.

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 A recent opinion issued by the federal Southern District of Texas sheds a little light on the question of how definite a promise to provide confidential information must be for a noncompete agreement to be enforceable. In Teel v. Hospital Partners of America Inc., No. H-06-3991, 2008 WL 346377 (S.D. Tex. Feb. 6, 2008), the court, quoting the Light case, noted that an "employer's promise to provide an employee with confidential or proprietary information and an employee's reciprocal promise not to disclose such confidential information `would meet the requirement that the covenant be designed to enforce the employee's consideration provided in the agreement.'"

The agreement in Teel stated that the employee's employment "will involve access to and work with" confidential information. The court, without discussion of whether this language was a sufficiently definite promise to provide confidential information, simply confirmed that the employee did in fact receive confidential information and that the restrictions imposed upon the employee were reasonable. 

As noted elsewhere on this blog, several Texas cases discuss how definite the employer's promise to provide confidential information must be for the employee's non-compete promises to be enforceable. Although the Texas Supreme Court in Sheshunoff rejected appellate decisions requiring that confidential information be transferred simultaneously with the signing of a non-compete agreement, it did not explicitly do away with the requirement that the employer actually promise to give the information to the employee.

The question in some cases becomes, "What counts as a promise?" Put another way, "How definite must the promise to provide confidential information be?" In some cases, the employee’s “acknowledgment” that he will receive confidential information gets characterized as an "implied" promise by the employer to convey the information. In the Teel case, the statement that the employee's work "will involve access to and work with" confidential information was evidently deemed to be a promise--either explicit or implied--that the employer would provide such information to the employee.

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In a recent Texas case involving a restrictive covenant, the plaintiff contended that the duration of the non-compete covenant should be judicially extended beyond the agreement’s normal expiration date. In that case, the seller of a dance studio entered into an agreement in which she promised not to compete with the buyer. As is true in most states, non-compete covenants contained in buy-sell agreements are more enforceable than those contained in employment agreements. The covenant in this case was for five years, and the geographical scope consisted of a 50-mile radius around Waco.

The buyer subsequently sued the seller, contending that the latter was in breach of the non-compete agreement. The trial court granted the plaintiff’s motion for summary judgment and an appeal was taken.

On appeal, the seller contended that the trial court erred in holding that the ending date of the covenant not to compete was five years from the date of judgment (as opposed to five years from when the non-compete agreement was signed). The buyer responded that the trial court was right to “equitably extend” the duration of the covenant because of the seller’s “continuous and persistent” violations of the covenant.

The evidence for the alleged “continuous and persistent” violation was as follows:

The Sale and Purchase Agreement was signed on February 27, 2004. Lezley did not begin working for Unity Dance and the Bratchers until July 11, 2005. On August 31, 2005, the trial court temporarily enjoined Lezley from either directly or indirectly soliciting or encouraging any current and/or potential students of Holley's dance studio, Jenni Holley Dance Designs, to become either her student or the student of any other dance company or teacher within 50 miles of Holley's dance studio. She was not specifically enjoined from teaching dance. Unity Dance and Bill and Donna Bratcher were enjoined from either directly or indirectly using Lezley's name in their advertising. They were also enjoined from soliciting or encouraging by direct contact any persons known by them to be current customers of Holley's dance studio as long as Lezley was working at Unity Dance. There is no indication in the record that Lezley, Unity Dance, or the Bratchers violated this temporary injunction.

Based upon these facts, the court of appeals held that the trial court erred in equitably extending the non-compete covenant.  However, the court also stated, “We do not hold that a covenant not to compete cannot be equitably extended, but hold that the record does not support Holley’s argument that the violations of the covenant, if any, were `continuous and persistent.’” 

Farmer v. Holley, 237 S.W.3d 758 (Tex. App.--Waco 2007), review denied.

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What happens if an employer seeking to enforce a non-compete agreement is itself in breach of the agreement.  Does the employer's previous breach adversely affect its ability to enforce the non-compete?  Maybe.

It's "hornbook" law in Texas that one party to a contract is precluded from enforcing a contract if that party itself is in “material” breach. In DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 682 (Tex. 1990, the Texas Supreme Court explicitly recognized that an employer in material breach of an employment agreement could be estopped from enforcing the non-compete provisions contained therein.  Of course, an issue in every case will be whether, assuming the employer is in breach, the breach is “material.”  Failure to pay compensation to which the employee is entitled might, in appropriate circumstances, qualify as material.  Thus, an employer wishing to enforce a non-compete agreement should ensure that it is not already in material breach.

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Texas courts routinely hold that at-will employment is "illusory" consideration.  Because the employer is free to terminate the employee at any time, the courts reason, giving an at-will job to someone is, legally speaking, meaningless.  Thus, non-compete agreements in Texas based upon that consideration are unenforceable.

Not all states agree.  While researching a noncompete matter in Illinois the other day, I came across this passage from a case there:
 

To be enforceable, a covenant not to compete must be ancillary to either a transaction (an otherwise valid contract), or a valid relationship.  Although an at-will employment agreement, whether written or oral, might not be considered "enforceable" in the strictest sense of the term, it is nonetheless an agreement and relationship with numerous legal consequences, imposing rights and obligation son both parties.  Therefore, a noncompetition covenant entered into by an at-will employee, whether the employee is employed under a written or oral agreement, complies with the requirement of ancillarity.  This is because a covenant in such a situation is not a "naked" restraint on trade, but instead is merely ancillary to the primary purpose of the relationship: an employer-employee relationship.  Thus, noncompetition covenants occurring in at at-will employment relationship are not enforceable per se.

According to this court, hiring an at-will employee subjects an employer to potential legal risk.  For example, the employee, even though she is at-will, is entitled to all protections under Title VII, the ADA, the ADEA, workers' compensation laws, the FMLA, and other laws.   The Illinois court held that at-will employment, therefore, is good consideration, not "illusory" consideration.  Although Texas courts disagree, it's interesting to examine foreign law holding otherwise.

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Texas courts have long held that Texas law should determine whether non-compete agreements affecting Texas residents are enforceable.  As a result, Texas courts generally will not enforce out-of-state choice of law provisions.  However, as a recent Texas Supreme Court case illustrates, contractual forum selection provisions can alter that result.

In Re AutoNation, Inc. involved a suit filed in Broward County, Florida, by a Florida corporation (AutoNation) against one of its former employees for allegedly violating a non-compete agreement.  A forum selection provision in the agreement mandated that suit be filed there. 

Shortly thereafter, the former employee--who lived and had worked for AutoNation in Texas--filed suit in Texas state court, seeking a declaration that the non-compete agreement was unenforceable under Texas law, and seeking to prevent the Florida suit from going forward.  The ex-employee, citing some Florida case law, contended that a Florida court likely would apply Florida law to the contract.  Given Texas’ strong public policy favoring the application of Texas law to the contract, the ex-employee argued, a Florida court should not be permitted to adjudicate the dispute. The Texas trial court agreed and enjoined AutoNation from taking further legal action against the ex-employee outside of Texas.  The trial court held, "Texas public policy will likely be thwarted if AutoNation is permitted to litigate enforceability of the restrictive covenants solely in Florida and solely under Florida law."  The court of appeals affirmed.

The Texas Supreme Court reversed.  In doing so, the court held that forum selection clauses--unless procured through fraud or overreaching--are enforceable.  The court also acknowledged Florida's interest in the dispute (given that AutoNation's headquarters were located there).  The court then refused "to presume to tell the forty-nine other states that they cannot hear a non-compete case involving a Texas resident-employee and decide what law applies, particularly where the parties voluntarily agree to litigate enforceability disputes there and not here."

In a concurring opinion, Justice O'Neill wrote:

What is not apparent . . . is that enforcement of the forum-selection clause in this case will result in application of the contractual forum's law in a manner that will undermine Texas public policy. Had there been a clear showing to this effect, I might agree with the court of appeals' analysis, or at least would consider the trial court justified had it decided to abate the Texas declaratory judgment action pending the Florida court's decision. But a mere indication that the Florida court intends to apply Florida law does not, without more, justify a Texas court's interference with the parties' chosen forum.

Time will tell whether Justice O'Neill's concurrence takes some of the bite out of this decision.  Based upon her concurrence, the next Texas resident who's sued in a foreign jurisdiction for allegedly violating a non-compete agreement may contend: (a) the foreign jurisdiction is likely to apply its law and (b) that law is contrary to Texas public policy.  The latter point might be made, for example, if the foreign state’s law is that at-will employment is sufficient consideration for a non-compete agreement (as opposed to Texas law, which states that such consideration is “illusory”).  Whether a stronger showing on the public policy issue than was made in this case could change the result is unknown.

In the meantime, given Texas’ relative hostility to non-compete agreements, out-of-state companies who have employees here should consider adding non-Texas forum selection provisions to their non-compete agreements.  Based upon this decision, they may be enforceable.

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Non-compete agreements routinely provide for the employer to get injunctive relief in the event the employee engages in post-employment competition. In a recent case, the agreement in question subjected the employee to potentially harsher penalties. 

The non-compete in question contained the following provisions:

14.     Restrictive Covenant. In consideration of the benefits being provided to the Employee pursuant to this Agreement as outlined in Section 12 and elsewhere, and the unique nature of the Firm's Clients and their business with the Firm as outlined in Section 12, the Employee shall neither call nor solicit, either for himself or for any other Person any of the clients of the firm for a period of twenty-four (24) months immediately following the Employee's period of active employment (the "Post Termination Period")….

15.     Payments to firm. …[T]he Firm and the Employee agree that should any Client of the Firm retain the services of Employee or any Person with whom Employee is associated at any time during the "post Termination Period", regardless of whether or not solicited by the Employee or such Person, the Employee shall pay to the firm an amount equal to 150% of the fees billed and accepted by such client during the twelve month period preceding the time when the client retains the services of the Employee or any Person with whom Employee is associated….

The court refused to uphold these provisions on the following grounds:

First, the court held that the monetary penalty was unreasonable. The court explained it in this way:  “[I]f Hardy prepared a $500 tax return for a client, and if the same client paid $50,000 during the previous year for accounting services provided by Mann Frankfort, Hardy would have to pay $75,000 to Mann Frankfort."

The court believed this to be excessive.

Second, the court objected to the “Restrictive Covenant” provision:

Hardy's restrictive covenant is not limited to the clients that he served. The agreement states that he may not call or solicit "any of the Clients of the Firm" for 24 months. The client-purchase provision similarly refers to "any Client of the Firm."  This type of restrictive covenant that does not require a connection between the clients and the person who is restricted by the covenant is overbroad. 

The court continued:

The agreement contains no geographical restrictions, no restrictions to clients that were actually served by Hardy while he was employed by Mann Frankfort, and an exorbitant fee for Hardy's service to clients that did business with Mann Frankfort.  We hold the restrictive covenant is unenforceable due to its failure to comply with the requirements of the Texas Business Code.  Because Hardy's agreement fails to comply with the Covenants Not to Compete Act, it is unenforceable, as written. (citation omitted)

In all cases involving non-compete agreements, the non-compete restrictions must be reasonable to be enforceable. In this case, the court held that the restrictions were unreasonable.

Hardy v. Mann Frankfort Stein & Lipp Advisors, Inc., 2007 WL 1299661 (Tex. App.—Houston [1^st Dist.] May 3, 2007).

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Here's an interesting article about a proposed bill in Tennessee to make physician non-compete agreements enforceable.  The proposed bill is in reaction to a Tennessee Supreme Court ruling that noncompete agreements are void unless specifically allowed by the state legislature:
 

http://phoenix.bizjournals.com/memphis/stories/2007/06/04/daily32.html

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In a recent case in Houston, the First District Court of Appeals upheld a trial court’s failure to reform an overly broad covenant not to compete. The covenant was overly broad in three respects: (a) there was no geographical limitation; (b) the covenant prohibited the employee from contacting all of his former employer’s customers, not merely the customers with whom the employee personally dealt; and (c) the employee was required to pay a harsh financial penalty if any customer continued doing business with him (whether or not the employee solicited the customer).

Tex. Bus. & Com. Code § 15.51(c) states in part:

[T]he court shall reform the covenant to the extent necessary to cause the limitations contained in the covenant as to time, geographical area, and scope of activity to be restrained to be reasonable and to impose a restraint that is not greater than necessary to protect the goodwill or other business interest of the promise and enforce the covenant as reformed, except that the court may not award the promise damages for a breach of the covenant before its reformation and the relief granted to the promise shall be limited to injunctive relief. (emphasis supplied)

Despite this provision’s seemingly mandatory requirement that an overly broad covenant be modified, the trial court failed to do so, for two reasons. First, the employer did not plead for reformation. Second, the employer only sought damages. The latter point was significant, the court believed, “because the only relief available under a reformed covenant—injunctive relief—was not sought by [the employer].” 

Practice pointer: In cases in which you believe the covenant may be too broad (which may be true in some respect in most cases), plead for reformation. Also, seek injunctive relief, even if you don’t think you’re entitled to a temporary restraining order, to increase the likelihood that the court will view reformation as something that is warranted.
 

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Interesting piece on increasing pervasiveness of non-compete agreements throughout the United States:
 

http://minnesota.publicradio.org/display/web/2007/04/24/noncompete/

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As we noted last week, how strongly an employer must promise to provide confidential information to have an enforceable non-compete agreement remains unclear, even after Sheshunoff.  Interestingly, though, there appears to be some divergence on the issue between the Dallas and Houston courts of appeal.  And the Austin court seems to be sympathetic to the Dallas court’s position.

Before Sheshunoff, the Dallas court, in three cases (C.S.C.S., Strickland, and Tom James), appeared skeptical that language such as “may reveal,” “Employee will become familiar with,” and “this Agreement is intended to recognize that Employer provides Employee with confidential information,” obligated the employer to provide such information.  However, in two of the cases, the fact that the alleged promises depended upon continued at-will employment were key factors in the decisions.  And the third case—C.S.C.S.—involved the weakest language (“may reveal”). 
 

However, the Houston court—or, at least, the First District of that court—held that an employee’s acknowledgement that she would get confidential information constituted an implied promise by the employer to give the information.

In the well-known Trilogy case out of the Austin Court of Appeals, the court seemed skeptical of the employee’s contention that his “acknowledgement” that he’d get information meant that the employer had impliedly promised to give it.  But the decision there hinged on the gap in time between the employee’s signing the agreement and receipt of the information.

Now that Sheshunoff has decided that a basis upon which several Texas courts had earlier voided non-compete agreements was--i.e., that a gap in time existed between  the employee's signing of the agreement and receipt of the information--was invalid, we can expect  further clarification on other disputed points, including how definite the employer's promise to provide the information must be.
 

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In the context of one company purchasing another company, a non-compete agreement is far more enforceable than it would be in an employer/employee situation.  That's hornbook law.  A good explanation for this was given in a Texas Supreme Court case:
 

In the case of covenants not to compete incident to the sale of a business, the seller's promise not to compete with the buyer increases the value of the business to the buyer.  Without such a covenant the value of the business would be reduced, lessening the likelihood that businesses would be purchased.  In employee covenants, the special training or knowledge acquired by the employee through his employer is valuable consideration and often enhances the value of the employee to other firms.  To allow employees to use or sell this valuable training or knowledge upon leaving a firm would create a disincentive for employers to train or educate employees.

Thus, in buy/sell situations, covenants not to compete are understandably easier to enforce, and their scope can be much broader than employer/employee covenants can be.

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In several states, an employer may--via a non-compete agreement--prevent a departing employee from taking advantage of the relationships the employee developed with the former employer's customers.  This is true whether or not the identities of the former employer's customers are "confidential."

In those states, therefore, the former employer can successfully contend, "We introduced you to our customers and you've developed good relationships with them, but you can't compete with us by taking advantage of those relationships."

There are actually a couple of Texas Supreme Court cases that stand for the proposition that protecting customer relationships is an interest sufficient to justify a non-compete agreement.  However, those cases have been largely ignored in recent years.

In Peat Marwick Main & Co. v. Haass, 818 S.W.2d 381, 387 (Tex. 1991), the court noted:

 

The fundamental legitimate business interest that may be protected by such covenants is in preventing employees or departing partners from using the business contacts and rapport established during the relationship of representing the accounting firm to take the firm's customers with him.

In an earlier case, Henshaw v. Kroenecke, 656 S.W.2d 416, 418 (Tex. 1983), the court had stated:

 

Henshaw had a right to protect himself from the possibility that Kroenecke would establish a rapport with the clients of the business and upon termination take a segment of that clientele with him.

Today, whenever an employee leaves and begins "stealing" his former employer's customers, courts focus on whether the identities of those customers are "confidential."  Usually, they are not.

To determine whether customer identities are confidential, courts ask questions such as, "Can the information be easily located (e.g., in telephone books or trade journals)?, and "Did the employer take reasonable steps to keep the information confidential?"  These standards are difficult to meet.

But in several other states, the employer need not prove that the information is confidential.  Rather, protection of the employer's relationship with its customer--whether or not the customer's identity is secret--is sufficient to support a non-compete agreement.  A few Texas cases used to speak in those terms as well.
 

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Even after Sheshunoff clarified the law governing non-compete agreements, we continue to see agreements that cause us to scratch our heads and wonder whether they are enforceable. Sheshunoff made clear that, even in an at-will employment situation, a delay between the employee signing the non-compete agreement and receiving the information is not fatal to the agreement’s enforceability.

However, “How strong must the promise be?” is a question that remains somewhat unanswered. Prior to Sheshunoff, several appellate court decisions considered agreements in which (a) the employee “acknowledged” that he would receive confidential information; (b) the employer expressed its “intent” to provide such information; (c) the employer promised to provide information to the employee that the employee “needed” to do the job, and so on.

In those cases, the employee routinely contended that the employer really didn’t promise anything (because the employer could decide not to provide information). Thus, the employee argued, the employer couldn’t rely upon an alleged promise to provide confidential information to justify the employee’s promise not to compete.

Unfortunately, many, if not most, of the pre-Sheshunoff appellate cases that dealt with these issues invalidated the non-compete agreements in question because the alleged employer promises were “illusory”—because they depended upon continued at-will employment.  Before Sheshunoff, a promise dependent upon continued at-will employment was meaningless.  After Sheshunoff, such a promise is enforceable.

Again, though, what is a “promise”?  Must the word “promise” appear in the agreement? Probably not. Terms such as “shall provide” or “agrees to provide” should suffice. But whether a simple “acknowledgement” by the employee that he will receive confidential information is enough is unclear. Some of the pre-Sheshunoff cases opined that terms like these might constituted “implied” promises on the part of the employer to provide information, but a lot of that language was dicta (because the cases were decided on the issue noted above). Now that Sheshunoff has held that the conveying of information need not occur at the moment of signing the agreement, we can expect to get some appellate decisions that squarely define how strong the employer’s promise must be.

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Company X's employee (who is bound by a non-compete agreement) resigns and begins working for Company Y (a competitor of Company X).  Company X sues its former employee for violating his non-compete.  Months later, they reach a settlement, and a final judgment is entered.

Company X can then sue Company Y for tortiously interfering with the non-compete agreement between Company X and its former employee, right?  Maybe not.

In KForce, Inc. v. Surrex Solutions Corp., 436 F.3d 981 (8th Cir. 2006), the federal Eighth Circuit Court of Appeals, applying Missouri law, held that filing a second suit (against the new employer) would result in the plaintiff being compensated twice for the same injury.  Thus, the second suit was barred.

Time will tell whether Texas courts adopt the holding in KForce.  However, just as in Missouri, it is the law in Texas that an injured party cannot be compensated twice for the same injury.  Thus, it's possible that the KForce rationale would apply here.

Lesson:  Be careful about settling with your former employee before you add his new employer as a defendant (unless you have no intention of ever doing so).  If you settle with the former employee, you may not be able to pursue the new employer.  The safest course, if you are inclined to seek relief (including injunctive relief) from both parties, is to name the ex-employee and his new employer as defendants from the outset.
 

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Another quick hit on the ramifications of Sheshenoff.  In recent years, employers have not infrequently added to their non-compete agreements a promise to convey confidential information to the employee, even if the employee no longer worked for the employer when the information was conveyed.  The purpose of this was to address the employee's argument that, "Because I'm an at-will employee, the employer's promise to provide me with confidential information is illusory because I could be fired before I get it."  Employers dealt with this by contending, "We promised to give him the information regardless of whether he was still employed--thus, our promise was not illusory."

One of the good things about Sheshunoff is that it makes game-playing like this no longer necessary.  Employers need not promise to give confidential information to departed employees.  Employers only need to promise to give the information and then do it (the sooner, the better).
 

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It's commonly believed--and rightly so--that the Texas Supreme Court's recent decision in the Sheshunoff case makes non-compete agreements relatively more enforceable.  However, let's keep in mind a couple of things that didn't change [even if these are obvious points].

Number one, even after Sheshunoff, if the consideration given for the non-compete agreement is confidential information, the employer must still promise to give it.  Sheshunoff rejects the notion that the confidential information must be provided at the moment the agreement is signed.  However, in that case, the employer did promise to convey the information.  Conversely, if the agreement in that case merely had the employee "acknowledge" that he might receive the information, the non-compete agreement likely would not have been enforced.  Thus, this element of Texas non-compete law has not changed.

On a related note, the confidential information must actually be confidential.  That's an obvious point, perhaps, but the bigger point is this:  the holding in Sheshunoff was not, "Non-compete agreements are now enforceable in Texas."  It was a lot more nuanced than that, and there are still many other requirements that must be met.
 

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Many management attorneys are breathing a huge sigh of relief today.  In a much-anticipated decision (oral argument was almost two years ago), the Texas Supreme Court clarified what it takes to make a non-compete covenant enforceable.  In doing so, the court resurrected many agreements that were previously thought to be unenforceable.

For years, Texas courts have held that, with respect to non-compete agreements, a promise dependent upon continued at-will employment is no promise at all.  Such a promise was "illusory," the courts held.  Thus, a promise to give an at-will employee a raise, a promotion, stock options, or confidential information was "illusory," unless whatever was promised was delivered at the precise moment that the employee signed the agreement (otherwise, the employer could terminate the employee before fulfilling its promise).

Perhaps the most severe application of this rule occurred in the Trilogy case, decided by the Austin Court of Appeals in 2004. There, an at-will employee signed a non-compete agreement at 10:00 a.m.  Four hours later, the employer said, "Here’s the confidential information that we promised to give you in the agreement you signed this morning."  When the employer subsequently tried to enforce the non-compete agreement, the court held that the four-hour gap between the employee’s signing the non-compete and his receipt of the confidential information rendered the non-compete unenforceable (because the employee could have been fired in the interim, even though he wasn’t). The fact that he could have been fired meant that the employer’s promise to convey the confidential information (made at 10:00 a.m.) was dependent upon the [at-will] employee still being employed when he finally received the information.  Because there was no guarantee that the employee would still be employed at 2:00 p.m., the employer’s promise made at 10:00 a.m. was "illusory."   

That decision, even though a logical extension of the law as it existed at the time, is no longer the law in Texas.  In a case decided a few days ago, the court held that even in the case of an at-will employee, a gap between the employee’s signing the agreement and his receipt of the confidential information will not render the agreement unenforceable.  The moment the employee gets the confidential information--whether it occurs four hours, four weeks, or four months after he signs the agreement--the non-compete agreement becomes effective.  

The court has clarified the law, in a much needed way.  Non-compete agreements are now relatively more enforceable.  And I have lost one of the few lines in my typical non-compete speech that ever got a laugh (or at least a grin)--when I demonstrated how an employer should have an employee sign the non-compete agreement with his right hand, while accepting the confidential information with his left.  That’s no longer necessary.  A delay between the employee signing the agreement and getting the information is no longer fatal.

There’s a lot more to the case, and we will be discussing it in depth in the days and weeks ahead. But it’s time to find the non-compete agreements that we thought were dead and see if this decision has resurrected them.

Alex Sheshunoff Mgmt. Servs., L.P. v. Johnson, et al., No. 03-1050 (Tex. Oct. 20, 2006).

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One of the most frequently-litigated issues involving noncompete agreements is whether the consideration given by the employer was adequate. There are generally two parts to the inquiry: one, whether the consideration given was real (i.e., not “illusory”); and two, whether the consideration given justified the noncompete agreement in question.

Giving a definite term of employment satisfies the first requirement, but it might not satisfy the second (because the court may not perceive a logical relationship between the term of employment given to the employee and the need to keep that employee from engaging in post-employment competition). Conversely, the giving of confidential information can satisfy the second prong, but if the promise to convey the information is not sufficiently definite, it may be held to be illusory.

In a case earlier this year, the consideration for the non-compete agreement consisted of:

        a.    a six-month term of employment;

        b.    employment beyond the initial six-month period for as long as the employer was satisfied with the employee’s work; and

        c.    a promise to convey confidential information.

Sometime later, the employee resigned, began working for a competitor, and was sued on his non-compete agreement. The employee contended that the non-compete was unenforceable. However, the trial and appellate courts disagreed, the latter holding that the employer “was obligated to fulfill its promises [to provide confidential information and specialized training] for at least six months.”  This promise to provide confidential information was held sufficient to make the covenant not to compete enforceable.

Thoughts:

1.  Courts have routinely held that a promise to provide confidential information in an at-will employment situation is not enforceable because there is no guarantee that the employee will get the information before she is fired (i.e., the employer might not get around to providing the information until days, weeks, or months after the agreement is signed).   Of course, if the employer promises to give the information when the agreement is signed, and does so, it might be enforceable.

2.  The facts of this case make the following argument by the employee possible:  "There was no guarantee that I would get the confidential information within the first six months of employment. Thus, my situation is not substantively different from an at-will employee who has no guarantee that he'll ever get the information he was promised." In this case, though, the court treated the above promises, collectively, as a guarantee that the employee would receive confidential information during the first six months of his employment (thereby making it a non-illusory promise).

3.  Belt and suspenders approach is best:  Combining a term of employment with a promise to provide confidential information at the instant the agreement is signed (and then doing it) is a good way to increase the likelihood that the non-competition agreement will be enforced.

4.  This is not to suggest that a term of employment per se makes a non-compete agreement enforceable.  The point of this case is, the court believed that a six-month term of employment meant that the employer's guarantee to provide confidential information (which gave the employer an interest in preventing competition) was not "illusory" (although the promise to provide confidential information might have been illusory in an at-will employment situation).



Pearson v. Visual Innovations Co., Inc., No. 03-04-00563-CV, 2006 WL 903736 (Apr. 6, 2006, no pet.).

 

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In a recent case, the employer's consideration in exchange for the employee's promise not to compete was set forth in the following provision:
 

Employer hereby agrees to provide to Employee any specialized training necessary, in the opinion of Employer, to allow Employee to conduct the duties of employment with Employer. Employer further agrees to provide to Employee any of Employer's proprietary and confidential information necessary to allow Employee to conduct the duties of employment with Employer.

The employee contended that this provision didn't obligate the employer to do anything, because the employer might have concluded that no specialized training (confidential information) was needed for the employee to do her job. The court [of appeals] disagreed:
 

[T]he trial court could have concluded that Rattikin was in fact bound to provide O'Brien with confidential and proprietary information and specialized training. The agreement merely gives Rattikin the option of determining, in its opinion, what confidential and proprietary information and training it should provide O'Brien during the course of her employment.

Observations:

1. The best practice for an employer is to unambiguously promise to provide confidential information at the moment the non-compete agreement is signed, and then do it.

2. This case illustrates the difficulty in predicting with certainty whether a particular non-compete agreement is enforceable. Clearly, the employee in this case had a plausible argument that the employer maintained sole discretion over whether to provide specialized training or confidential information, and that, therefore, the alleged consideration was "illusory." The court disagreed with this interpretation, but the employee (and her attorney) no doubt believed in the correctness of her legal position.



O'Brien v. Rattikin Title Co., No. 2-05-238-CV, 2006 WL 417237 (Tex. App.--Fort Worth Feb. 23, 2006, pet. filed).
 

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