Non-Compete Clauses: A Short Primer
As their name implies, a non-compete agreement is a contract between an employer and employee whereby the employee agrees that, once he or she leaves the company, they will not compete with their former employer in any way. Non-competes are a method through which companies limit their exposure to competition from former employees in order to protect their proprietary business information and trade secrets. They are essentially used as a way of ensuring that the work an employee did for the employer cannot be exploited for the former employee’s own gain once the employee is no longer tied to the company.
Since non-competes are one kind of restrictive covenant, the Texas Common Law pertaining to Covenants Not to Compete applies to non-competes unless the Texas Legislature has expressly governed non-competes through statute, such as the Texas Occupations Code regarding the enforceability of Covenants Not To Compete ("Covenants not to compete"), Tex. Occ. Code § 15.50-.52 . Contrary to popular belief, non-competes are not exclusive to the tech world or any other particular industry. They are common in all sectors of the economy, although the specifics of non-competes vary wildly from industry to industry. For instance, in the oil and gas industry non-competes that impose certain restrictions on low-level employees may be considered overbroad and unenforceable. Compare that to a sales representative within the oil and gas industry, where Courts are more likely to find a reasonable period of restriction enforceable against such an employee. In the medical field, it is not uncommon for many healthcare providers to require non-competes with their employees as an essential part of a compensation package. Therefore, while the purpose of a non-compete is generally the same from company-to-company, the specific circumstances of various businesses and companies will determine how those businesses actually implement non-compete contracts with their employees.
Relevant Law Governing Non-Compete Agreements In Texas
In Texas, the legality and enforceability of non-compete agreements is governed by Section 15.50-15.52 of the Texas Business and Commerce Code. Section 15.50 concerns Circumstances in Which Covenants Not to Compete Enforceable, and it provides that covenants not to compete are enforceable even if they are ancillary to an otherwise enforceable agreement, provided that the agreement is signed by the person against whom the covenant is sought to be enforced and meets three requirements:
Section 15.51(a) defines an enforceable "employee" covenant not to compete: To be enforceable, a covenant not to compete must be ancillary to an otherwise enforceable agreement. Specifically, to be ancillary, there must be "consideration besides the employment itself." Section 15.50 provides a list as follows: There are limited circumstances in which covenants not to compete by a physician, an attorney, or an accountant are enforceable. Section 15.50(b) clearly provides that: Finally, Section 15.52 provides for attorneys’ fees for prevailing party in injunction actions.
Essential Facets for Enforceability in Texas
To be enforceable, a non-compete must be ancillary to a contract and the terms must be reasonable. Tex. Bus. & Com. Code § 15.50(a). In analyzing whether a non-compete agreement exists, and whether it is enforceable, a Texas court will apply the two-part test set out by the Texas Supreme Court in Marsh USA, Inc. v. Cook, 354 S.W.3d 764 (Tex. 2011). First, is there evidence of the existence of an employer-employee relationship or other contractual relationship? Id. at 775. Second, if such a relationship exists, is there evidence that the covenant was ancillary or incidental to an otherwise enforceable agreement? Id. In addition, a Texas court will look at the reasonableness of the restrictions imposed by the non-compete. Id.[i] Texas courts apply a rebuttable presumption that a covenant is enforceable if it meets the basic criteria of being ancillary to an otherwise enforceable contract, and if its limitations as to time, geographical area, and scope of activity to be restrained are reasonable and do not affect the general public. Tex. Bus. & Com. Code § 15.50(a); see also Marsh, 354 S.W.3d at 775.
The reasonableness of a non-compete agreement in Texas depends on the facts surrounding the agreement, but certain requirements are consistent across the board. In Texas, the non-compete must be the least restrictive means to achieve the purpose of the non-compete. Marsh, 354 S.W.3d at 775. The limitations in the covenant cannot be greater than necessary to protect the employer’s legitimate business interest. Id. at 774. The agreement also cannot adversely affect public policy. Id.
Texas courts have narrowly construed the requirements for the enforceability of non-compete agreements. For example, if the agreement is ancillary to an otherwise enforceable agreement, that is sufficient for the agreement to satisfy the first part of the test, and the burden then shifts to the restraint actually to be fair and reasonable. See id. at 775. In other words, a non-compete agreement need not be a condition of employment in Texas to be enforceable.
[i] An exception to the general rule that Texas law will apply if the agreement was entered into for execution in Texas exists when the "restraint is ancillary to an otherwise enforceable contract, performance is to take place in another state, and the parties do not have a ‘substantial connection’ to Texas and the relationship did not have ‘a substantial connection’ with Texas at the time the parties agreed to the restraint." Marsh, 354 S.W.3d at 769.
Exemptions from Enforceability
If you are in over your head when it comes to abiding the terms of your non-compete agreement, don’t assume that there’s nothing you can do to extricate yourself. There are a number of scenarios in which a non-compete agreement may be void or unenforceable, including: The Non-Compete is Overly Broad The bane of both employers and employees alike, overly broad non-compete agreements seem to be everywhere. A non-compete agreement is deemed overly broad when, for example, it is not limited to your legitimate competitive interests. This means that it may be void and unenforceable.
The Non-Compete’s Legitimate and Business-Specific Interests are Unrelated to Your Employment Sometimes, an employee’s agreement not to compete may have little or nothing to do with the legitimate interests of his/her employer. For example, if an employee was hired solely as a sales representative, is he/she really going to take away the employer’s competitive advantage by merely working for a competitor for a year or two? Obviously not. A non-compete agreement of that caliber may be void.
The Non-Compete is A Proxy for a Severance Agreement Sometimes, an employer will offer you a severance package in exchange for signing a non-competition agreement. In this case, the non-compete agreement is only a thinly veiled severance agreement; the real purpose of the agreement is to separate you from your severance check. If the employer continues to employ you, it’s possible that the non-compete agreement may be void and unenforceable.
The Non-Compete Violates Public Policy In general, any contract that violates public policy is void and unenforceable. Although enforcing a non-compete agreement is usually in the best interest of the company and/or the individual, in certain situations it may not be in: the best interest of the company; the best interest of the individual; and/or the best interest of the public. As such, if a court determines that the clauses in a non-compete agreement (or the entire agreement itself) violate public policy – perhaps, for example, because it has become far too one-sided – then the non-compete agreement may likely be void and unenforceable.
Latest Case Law & Innovations
Texas courts have had a number of recent opportunities to review noncompete agreements and enforceability. A few recent Texas cases show that some provisions routinely appearing in non-competes are unenforceable in Texas. One such provision is a choice of law provision.
In Paty v. Boyd, the Texas Fifth District Court of Appeals in Dallas held that identical noncompetition and confidentiality provisions in an agreement with technology solution providers were void and unenforceable because they included a choice of law provision designating Pennsylvania law, which is more restrictive than Texas non-compete law.
In Paty, the Court noted that Texas has adopted the Uniform Declaratory Judgment Act. The Court relied on Section 37.004 of the Act, which empowers Texas courts to declare rights, status, and other legal relations whether or not further relief is or could be claimed. The Court went on to hold "Particularly because our judgment is binding on all parties to this cause , irrespective of whether any post-judgment activity ensues under the agreement, we hold that [the noncompete agreement] is void and unenforceable because it contravenes Texas public policy and law, and we declare the rights of the parties."
Some Texas appellate courts have even gone so far as to suggest that including a liquidated damages clause would allow the Court to reform an otherwise unenforceable agreement. However, more recent decisions have cast doubt on this theory. The Fifth Circuit federal Court of Appeal has held a liquidated damages clause is inappropriate to reform or amend a non-compete unless it is in the public interest. It is still unclear whether Texas Courts will continue use of the liquidated damages clause or carve out another exception to reform or amend the non-compete agreements.
Best Practices when Drafting Compliant Provisions
When drafting a non-compete in Texas, there are several things employers and their attorneys should do to avoid trouble later. First, the non-compete should be part of a signed agreement containing reciprocal covenants from each side. That is, the employee should be getting some sort of consideration on the front end. If one side just provides an indefinite amount of work in exchange for the covenant, a court will strike down the agreement. Second, careful attention should be paid to the parameters of the agreement. While the Gardner case suggests that no particular formula needs to be used, courts seem to look for at least a limited time period, geographical assessment, and some definition of what the employer is trying to protect. The agreements should be looked at as a whole, with each clause fitting into the scheme overall. Third, employers should be careful not to drag on the length of time for post-employment restrictions beyond what is needed. Courts tell us that the longer a restriction, the more likely it will be found unenforceable. Restrictions of 12 months or less have been upheld. But once you go past that, you run the risk of losing the case. Finally, employers should carefully measure and evaluate the legitimate business interests it is trying to protect. This is the core issue in every non-compete case that winds up in litigation. Take the time up-front to conduct the appropriate due diligence and then write the agreement to fit what the business needs to protect.
Non-Compete Agreement Alternatives
If your business’s policy used to include a blanket requirement that all employees sign non-competes, you may be rethinking your position now that the Texas Attorney General is filing suits against several companies for "unlawful non-compete agreements." Even if you do think that a non-compete may make sense for a certain employee, you should know that Texas law provides several alternative legal tools that can be just as effective.
Non-competition agreements do not always involve formal, written non-competes. Although it now has much stricter requirements under the new Texas non-compete law, non-competition agreements prohibiting former employees from engaging in competitive activity have generally been enforceable under Texas law for many decades. If a departing employee engages in competitive activity, then he or she may be sued for competing against his former employer by tortiously interfering with the former employer’s existing and/or prospective customer relationships. To recover damages, the former employer must prove that it had actual business relationships with one or more customers that were "interfered" with by the former employee’s actions in competing. If so, then the former employee can be held liable for actual and consequential damages, as well as for a share of the profits he made from the competitive activity, usually based on a theory called "tortious interference with prospective contracts."
The downside of these tort claims is that they do not provide any threat of criminal sanctions. A former employee’s conduct in competing with his former employer may not rise to the level of criminal theft of trade secrets or customer information because it might not constitute misappropriation, by improper means, of any confidential information that was obtained through a confidential relationship in connection with the employee’s employment with the former employer.
If, however, the departing employee did misappropriate your company’s trade secrets or confidential customer information, then as discussed in the article on "What are Trade Secrets?," the employee may be liable for both civil and criminal theft of trade secrets. But, assuming that the employee does not have a formal non-compete agreement, a non-disclosure agreement would be much easier to comply with if the employee were to misappropriate your company’s trade secrets or other confidential customer information in order to use that information in a competing venture. A non-disclosure agreement’s pronouncement of the confidentiality of certain information is considered proof that the information in question was confidential and secret, which is one of the requirements for a civil or criminal violation of the Texas Uniform Trade Secrets Act (TUTSA) and the Theft of Trade Secrets Act. A former employee cannot be criminally charged with theft of trade secrets if there is no non-disclosure agreement in place that identifies the types of confidential information that qualify as trade secrets.
Also, for purposes of tortious interference with prospective contracts under Texas law, if the departing employee does not have a formal non-compete agreement, then there is little that can be done to prevent the employee from soliciting your company’s customers (assuming that the circumstances present a prima facie case for tortious interference). However, a non-disclosure agreement requires that the employee promise not to solicit customers after employment with your company ends. Assuming the customer constitutes a "prospective" contract with your company, prospective contracts fall within the protection of the tortious interference doctrine if the elements of the tort are present in the given situation.
Depending on the nature of your company’s business, you may require employees to pay a bond in order to fund your company’s replacement of any employee who resigns. This bond right may seem extreme, but can be a reasonable precaution in certain situations, such as requiring a nurse to pay a bond to compensate a hospital for the expense it takes in hiring a new nurse to replace the nurse who quit. However, if the employee obtains new employment with a competitor, then your company may not be able to recover the amount of the bond for a variety of legal reasons, including the reason that such a bond may qualify as an invalid restraint of trade under Texas law. Even if the bond right would qualify as a valid restraint of trade under the new Texas non-compete law, if the covered employee was not required to return to your company as a condition of receiving a job offer with a competitor, then the restriction on his compensation would not be enforceable under the new Texas non-compete law.
Another solution is to have your departing employee sign a non-solicitation agreement to restrict the employee’s solicitation of your company’s customers after the employee leaves your employment. A non-solicitation agreement would not be in violation of Texas’s prohibitions on covenants not to compete, if the agreement does not restrict the activities of the employee’s future employer on behalf of the departing employee. Given the potential expense involved in departing employees’ soliciting your company’s customers, a non-solicitation agreement seems more reasonable than a bond right that your employees may be required to pay.
Future Updates & Modifications
A handful of bills have been proposed in the last state legislative session that would have prohibited non-compete agreements with employees who earn less than $15 per hour. None of these bills were passed this legislative session. However, it is possible that similar attempts to abolish the enforceability of non-compete agreements in Texas will be on the agenda in subsequent legislative sessions. This change, however, would have to be made at the state level and is, as of now, limited to the Texas Legislature.
Many labor leaders and employers are anticipating a possible national labor law change regarding non-compete agreements. National labor leaders have stated that they are pursuing various initiatives at federal agencies such as the Federal Trade Commission (FTC). For example , on May 6, 2016, Senator Sanders brought new scrutiny to whether the FTC could adopt a rule that would ban non-compete agreements that do not affect public interest. However, the FTC has shown little sign of activity in this space.
Nonetheless, if federal labor laws were to change, the new law would likely follow the precedent set by the states that outright ban non-compete agreements or limit the scope of enforceability. These changes, however, would have to be enacted at the federal level by the President and Congress and would require the agreement of one or more federal agencies. In the meantime, Texas employers seeking to impose non-compete restrictions on their employees must continue to follow the existing standards for non-compete agreements.
