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

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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I often hear from employees who are bound by non-compete agreements that "Texas is a right to work state," and that, therefore, their agreements are unenforceable.

Not true.  The "right to work" concept has NOTHING to do with non-compete agreements.

Rather, the "right to work" concept has to do with the right of employees to decide for themselves whether they will financially support a union (assuming there is one).  It has nothing to do with whether non-compete agreements are enforceable.  Nothing whatsoever.

So, if you are bound by a non-compete agreement and someone says, "That's unenforceable--Texas is a right to work state," ignore them.  

 

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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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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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Special requirements must be met for a physician to be bound
by a non-compete agreement in Texas. In addition to the requirements discussed in other posts, the covenant must:
 
• not deny the physician access to a list of his patients whom
he had seen or treated within one year of termination of
the contract or employment

• provide access to medical records of the physician's
patients upon authorization of the patient and any copies
of medical records for a reasonable fee

• state that any access to a list of patients or to patients' medical
records after termination of the contract or employment shall not
require such list or records to be provided in a format different than
that by which such records are maintained except by mutual consent
of the parties to the contract

• provide for a buy out of the covenant by the physician
at a reasonable price or, at the option of either party,
as determined by a mutually agreed upon arbitrator or,
in the case of an inability to agree, an arbitrator of the
court whose decision shall be binding on the parties
 
• state that the physician will not be prohibited from
providing continuing care and treatment to a specific
patient or patients during the course of an acute illness
even after the contract or employment has been
terminated.
 

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An employer may be entitled to injunctive relief to enforce a non-compete agreement in Texas. To obtain permanent injunctive relief, it is not necessary to prove that, without an injunction, the promisee will suffer irreparable harm. But that is not the case with respect to temporary injunctive relief.  Most courts hold that to obtain temporary injunctive relief to enjoin violation of a non-compete provision, one must prove irreparable harm (i.e., that money damages are inadequate).

Irreparable harm may exist if the damages resulting from the breach are hard to quantify, or if the injury cannot be compensated in damages. The threatened disclosure of trade secrets to a competitor can constitute irreparable injury, especially if it would enable a competitor to gain a competitive advantage. Moreover, proof of a continued breach of a non-compete agreement by a highly-trained employee may constitute irreparable harm. In determining whether to grant temporary injunctive relief, the court must balance probable harm to the employer if the injunction is not issued with probable harm to the employee if it is.

In addition to injunctive relief, a court may award damages resulting from breach of a non-compete covenant. Awardable damages might include lost profits resulting from the departing employee's breach of the noncompetition agreement. A non-compete agreement can contain a liquidated damages provision, but the provision must constitute a reasonable forecast of just compensation for the harm caused by the breach.
 
If the court holds that the scope of the non-compete agreement is too broad (e.g., if the court holds that the geographic scope should be limited to Dallas /Fort Worth rather than to all of
Texas), it will reform the scope to make it reasonable. However, if reformation of the scope is required, damages may only be awarded for "post-reformation" violations. For this and other
reasons, an employer has an incentive to ensure that the scope of a non-compete agreement is reasonable.

Attorney's fees and costs may be awarded to the promisor (employee) if he proves that: the scope of the covenant is unreasonable, the employer knew at the time the agreement was signed that it was unreasonable, and the employer has attempted to enforce the covenant to a greater extent than necessary to protect its goodwill or other business interests. Texas cases also hold that an employee who seeks a judicial declaration that a covenant not to compete is unenforceable and void in its entirety may be entitled to recover attorney's fees under the Texas Declaratory Judgment Act.
 
There is no provision in the non-compete statute for an employer who successfully prosecutes an action against an employee to recover attorney's fees.  At least one Texas court of appeals has held that the non-compete statute's silence on this issue precludes an employer from recovering its fees under the statute (or any other applicable law).  However, another Texas court has permitted an employer to recover its fees under the Texas statute allowing the prevailing party in a contract dispute to recoup its attorney's fees.
 

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A non-compete agreement in Texas must not impose upon the employee greater restraints than are necessary to protect the business and goodwill of the employer.  Moreover, the scope must bear some relationship to the activities of the employee.  It is generally permissible to keep an employee from soliciting business from customers with whom he dealt during his employment, and it is likewise generally permissible to restrain the employee from competing in the geographic area in which he worked.  Thus, an employee who works in Dallas might be prevented from post-employment competition in Dallas (but he might be able to complete in Houston). In terms of the appropriate length of the covenant, although covenants typically are 1-2 years in length, courts have upheld restrictions of 2-5 years in length (or longer in the context of a business purchase).  In the event a covenant is too broad, the court will reform it so that it is reasonable.

 

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Once an otherwise enforceable agreement has been found to exist, the next question is whether the non-compete provision is "ancillary" to that otherwise enforceable agreement. Texas courts have made it clear that the following must be true for a covenant not to compete to be ancillary to an otherwise enforceable agreement:
 
•The consideration given by the employer [in the otherwise enforceable agreement]
  must give rise to the employer's interest in restraining the employee from competing.

•The covenant not to compete must be designed to enforce the employee's return promise [contained in the otherwise enforceable agreement].

In the typical scenario, the employer contends that confidential information it provided to the employee gives rise to its interest in restraining competition. That contention intuitively makes sense:  if the employer gives the employee the employer's most important secrets (e.g., financial information, customer lists, marketing strategies, research and development plans, etc.), it makes sense that the employer would not want the employee taking those to a competitor. Of course, the employee could always argue, "The non-disclosure agreement I signed prevents me from disclosing those items to a competitor, thus the non-compete is unnecessary." But the employer's obvious rejoinder is, "Once you leave us and begin working for a competitor, our ability to monitor your activities is virtually nonexistent. Thus, we need not only a non-disclosure agreement, but also a covenant not to compete." In some cases, the employer is able to convince the court that the promises it made and the confidential information it gave justifies the non-compete provision. The employee's promise not to disclose the confidential information usually satisfies the
second prong of the test.
 
To be confidential, information must be "secret," and if information is publicly available, it probably will not be deemed confidential. For example, information about customers that is publicly obtainable (e.g., from telephone books, industry journals, or even the employer's website) may be held not to be confidential.

Confidential information is not necessarily the only consideration that can justify a covenant not to compete.  For example, giving an employee ownership in a company, particularly a privately-held business, may support a non-compete. However, confidential information may be the best consideration that can be given, because the connection between the information conveyed and the employer's need to maintain its secrecy via a non-complete agreement makes sense.
 
Some employer promises that satisfy the otherwise enforceable agreement requirement may not satisfy the "ancillary" requirement. For example, an employer may satisfy the otherwise enforceable agreement requirement by giving the employee a term of employment. But a term of employment may be held insufficient to give rise to an interest in restraining competition. To determine whether a particular item of consideration is sufficient to support a non-compete covenant, one might ask, "Is there a logical relationship between the consideration given by the employer and the non-compete covenant the employer seeks to enforce?" If the consideration in question is confidential information, a logical relationship may be found to exist. But other types of consideration—e.g., a signing bonus—may be found lacking by that standard.
 
It is important to emphasize that the "ancillary" requirement is far easier to meet in the context of a purchase of a business than in an employment situation.  Another key difference between a non-compete agreement in a purchase of a business context and an employer/employee context: In the former, the burden is on the promisor (i.e., the person agreeing to be bound by the non-compete) to prove the agreement is unreasonable; in the latter, the promisee (employer) must prove the agreement is reasonable.
 

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Non-competition covenants are typically contained in written (employment) agreements that contain many other provisions. The first step in determining whether an enforceable non-compete agreement exists is to mentally draw a line through the non-compete provision and examine the remaining provisions. The pertinent question with respect to the remaining provisions is: Have both the employer and the employee made binding promises to each other? Both the employer and the employee must make binding promises for the non-compete covenant to have any chance of being enforced.

Usually, whether the employee has made a binding promise to the employer is not at issue. Employees typically promise not to disclose confidential information, to return company property upon termination, etc. Promises such as these are binding.
 
The issue that gets litigated much more often is whether the employer has made a binding promise to the employee. This question arises most frequently when the employee is employed "at-will." Many Texas courts have held that an employer's offer of at-will employment (i.e., an employment relationship in which the employee can be terminated at any time for any reason) is meaningless (or "illusory," as the courts say). Thus, if the only consideration given by the employer for the non-competition covenant is at-will employment, the employee can have a high confidence level that the covenant is unenforceable.

Another type of consideration that courts routinely have rejected is past consideration. Many times, with respect to an incumbent employee, an employer will hearken back to consideration previously given. For example, a non-compete provision may be supported by "confidential information received by the employee in the past." Courts have held that past consideration is no consideration at all. Thus, if an incumbent employee is to be bound by an enforceable non-compete covenant, the employer must give new consideration.
 
So what consideration can the employer give to satisfy the "otherwise enforceable agreement" requirement? Clearly, a definite term of employment (e.g., a one-year term) would be sufficient. Likewise, an at-will employee who, despite his "at-will" designation, is entitled to thirty days' written notice before being terminated has been given good consideration (i.e., he has, in effect, a thirty-day employment contract).
 
One of the most-litigated issues involves the extent to which a provision stating that an employee will receive confidential information (or specialized training) constitutes a binding promise by the employer. Often, the agreement merely recites that the employee "acknowledges" she will receive confidential information. Particularly where the employee is at-will, an acknowledgment may be insufficient because the employer may be held not to have actually promised to do anything. The employee may contend that her "acknowledgment" does not actually guarantee that the employer will provide confidential information. Because only the employer's promise can guarantee that confidential information will be given, so the argument goes, no promise by the employer equals no consideration. This contention has found favor with some courts.
 
An employer's promise to provide confidential information is probably good consideration, as long as the employer actually does so.
 
As noted above, the existence of an "otherwise enforceable agreement' is a prerequisite to a non-compete provision being enforceable. But it is not sufficient to make the covenant enforceable.  If this threshold requirement is met, the next question is whether the non-compete provision (which is not even relevant in assessing whether an otherwise enforceable agreement exists) is "ancillary to the other enforceable agreement at the time the agreement was made."  That requirement will be discussed in another post.

 

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In Texas, non-compete agreements are generally disfavored as unlawful restraints on trade. Courts recognize that in our capitalist economic system, workers must be free to compete with each other, work where they wish, etc. However, the law also acknowledges that an employer may have interests that are important enough to warrant restrictions on post-employment competition.

Whether a particular non-compete agreement is enforceable in Texas cannot be known with absolute precision. The law in this area is complex, courts frequently differ with each other, and much depends on preferences of individual judges. However, both the law and experience provide useful guidance.

A non-compete covenant is typically just one provision contained in a larger employment agreement. In Texas, for a non-compete covenant to be enforceable, the following requirements must be met:

•An otherwise enforceable agreement must exist.

•The noncompete covenant must be "ancillary" to the otherwise enforceable agreement at the time the agreement is made.

•The scope of the noncompete covenant must be reasonable in terms of time, geographical area, and scope of activity to be restrained, and must impose restrictions no greater than necessary to protect the employer's goodwill or other business interest.

These requirements are explained in other posts in this Overview section.

 

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