Non-Compete Agreements
Non-Compete agreements are restrictive covenants that are intended to protect an employer/shareholder’s business interest from competition. Specifically, a common non-compete will generally restrict (1) competition by the former employee, (2) in a defined geographic area, (3) for a specific period of time.
While Texas Courts have generally expressed a disfavor toward non-compete or restrictive covenant agreements, they are still routinely utilized by companies in an effort to protect their legitimate business interests. Texas law was traditionally construed to be hostile to non-compete or restrictive covenant agreements and such clauses were considered void as against public policy unless they had a reasonable purpose. In 1989, the Texas Supreme Court modified the "ban against non-compete" argument and instead provided a six-prong test whereby the legality of a non-compete could be weighed and decided on a case-by-case basis . Since then, Texas Courts have continued to adopt this analysis, however, the contours of what constitutes a legitimate business interest have continued to be elucidated.
The Texas Legislature addressed non-compete or restrictive covenant agreements in 1989, requiring courts to exercise a balancing test based upon six factors to weigh the interest of both parties. It then codified these factors in Section 15.50 of the Texas Business and Commerce Code. This code section sets forth the requirements for a valid non-compete agreement. Section 15.50 states that a covenant not to compete that is ancillary to an otherwise enforceable agreement is enforceable for a period of time after termination of the employment relationship as long as the time period, geographical area, and scope of activity restrictions are reasonable and the limitations contained in the covenant do not impose a greater restraint than necessary as to the duration of the non-compete, geographical area, and scope of activity to be restrained to protect the goodwill or other business interest of the promisee.
Applicable Law in Texas
The Texas legal framework concerning non-compete agreements is primarily governed by Texas Business and Commerce Code § 15.50 (15.50). That section contains four rules, which are that its subsections apply to enforceability, a statute of limitation, that a contract cannot be assigned without mutual consent and attorney’s fees.
Then there is the Texas Business and Commerce Code § 15.51 and that sets out specific parameters to enforce non-compete agreements. First, the statute spells out permissible circumstances for non-compete agreements, which are broadly defined as:
A covenant not to compete is enforceable to the extent that it contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and, contained in a consideration for the covenant, are ancillary to an otherwise enforceable agreement.
- (1) Ancillary to an employment or professional service contract between an employer and employee or an independent contractor or a professional service between one or more professionals and a person furnishing the employment or professional or other services;
- (2) Ancillary to an agreement between one or more professionals and a person who hires the professional or to a contract for the purchase or sale of goodwill or ownership interests in a business entity; or
- (3) Ancillary to a partnership or limited liability company agreement.
The legislative language says said contracts must have limitations that reflect what’s deemed reasonable in terms of time period, geographic location and the scope of the activities sought to be restrained. So, what can that mean?
A case was considered where a contract prohibited an employee from engaging in competing businesses for periods as much as two years. In that case, the Dallas Court of Appeals said:
The scope, duration, and geographical area of the restrictions, when viewed in context, are reasonable under the circumstances. We construe "scope of activity to be restrained" to mean the particular operations to be restricted. The agreement reflects the scope of activities in which [the company] wanted to restrict [the employee] because [the company] was engaged in the business of acquiring, owning, renting, leasing, and managing commercial and industrial real property, and the prohibited activities were those types of activities in which [the employee] had participated while employed with [the company]. We conclude that the terms of § 15.50(a)(2) are satisfied under the circumstances of this case. The covenant not to compete is consistent with the purpose of protecting [the company’s] legitimate property interests, including its trade secrets, confidential information, client relationships, and goodwill, and does not impose a greater restraint than necessary to protect those interests.
Requirements for Enforceability
The most important factor in determining whether a non-compete agreement is enforceable is whether it is reasonable in time, geographic area and scope of work restriction. If the agreement is not reasonable, it is as if there were no agreement at all and it will be ignored.
Reasonableness factors into each of the categories: the time, area and scope of the contract. For example, if the non-compete clause limits the employee from competing for two years, it must be closely related to the time the employee worked for the employer to be more enforceable.
An agreed upon provision within the non-compete with more detail will often be upheld by courts. For example, if your non-compete clause states that you cannot compete within the state of Texas for two years, then that clause is narrow enough to be enforceable.
Limitations on covenants not to compete are detailed in Texas Business and Commerce Code, Chapter 15, § 15.50. Some of the key areas of the code are: Courts try to avoid invalidating non-compete agreements since they are valid under the law. An enforcing order can be requested even if the agreement is not reasonable if the rest can be separated.
Typical Challenges to Enforcement
When an employer moves to enforce a covenant not to compete, the employee may oppose the enforcement of a non-compete agreement on several grounds. A covenant will generally be unenforceable if it imposes greater restrictions than are reasonable necessary to protect the employer’s legitimate business interests. Texas also prohibits enforcement of covenants against former employees based solely on disclosure of information plainly contained in public records. Additionally, if the enforcement of the covenant would adversely impact the public interest, such as in a case involving a physician or other licensed professional, then the court may be required to refuse to enforce the agreement. Moreover, even if the covenant is enforceable, the employer must still prove that it will suffer irreparable injury at trial. That same inquiry may also lead to a determination that the covenants are overbroad and unenforceable or lead to modification of the covenant to impose only reasonable restrictions.
Recent Texan Court Decisions
Texas courts have both affirmed and overturned non-compete agreements in recent years, but they have been consistent with respect to the basic principles involved. The First Court of Appeals ruled in Ewing v. The Butter Cup, Inc. (Houston 14th Dist., No. 14-15-00098-CV, 2016 WL 3446817, June 23, 2016) that non-competes are not enforceable unless the duration and geographical restrictions are reasonable with respect to the business interests that are sought to be protected. The appeals court noted the trial court was justified in concluding part of the non-compete clause at issue in that case – which prevented a plaintiff from being specifically named as an officer of a competing enterprise for five years – was unreasonable.
The Fifth Circuit Court of Appeal ruled in Jewelers Mutual Insurance Co. v. the Adang Agency, LLC (No. 15-20424, August 5, 2016) that a former employee could not be required to arbitrate a dispute with his former employer because the non-compete agreement he had signed violated Texas law. The court ruled that the non-compete clause in question was not necessary to protect the employer’s legitimate business interests because the employer was not a true "employer," but rather an agent acting on behalf of the insurance company. The court ruled that the insurance company , not the agent, was responsible for the acts of its agents.
Texas courts have also ruled that technology can be protected through a non-compete agreement – even when that technology is neither patented nor patentable — without violating the Texas Uniform Trade Secrets Act. The author of a computer software program, for example, was sent a copy of a non-compete agreement that was not signed until years later in a separate but related real estate transaction; however, the court ruled in Semiconductor Energy Laboratory Co. v. Ch. Sgaana, Inc. (Austin, Oct. 7, 2016) that the original non-compete agreement remained enforceable under the Texas Uniform Trade Secrets Act. A court ruled in 2014 that a salesperson who had worked at an alarm sales company could not be bound by a non-compete agreement because the agreement would prevent him from working at his only means of support, but the Fifth Circuit ruled in 2016 in American Laser Skincare Holdings, LLC v. Barahona (No. 15-20246) that the non-compete was enforceable because it only restricted the employee from working at competing alarm companies that were under the same management.
Therefore, it is clear that Texas courts will look closely at the underlying circumstances of employment to determine whether an individual non-compete agreement is enforceable.
Alternatives to Non-Compete Agreements
When it comes to competition and confidentiality in Texas, there are a number of alternatives to non-compete agreements that are just as effective if drafted correctly.
The principal alternative to a non-compete is a non-disclosure agreement (or non-disclosure clause in a broader contract). Whereas non-competes restrict an employee’s ability to compete with a former employer after they leave the job, non-disclosure agreements prohibit employees from disclosing confidential information to outside parties while they are employed. While non-disclosure agreements do not restrict former employees from competing outright, they are a useful preventative tool against inside threats. If an employee decides to steal and publicize confidential trade secrets, a non-disclosure can serve as the basis of a potentially crippling lawsuit. Non-disclosure agreements may be even more useful for temporary, at-will workers who are not employed long enough for a judge to rule as to the enforceability of a non-compete.
In addition, when an employee leaves a job and joins a competitor, their former employer may bring a suit to prevent them from soliciting away other employees. Non-solicitation agreements are similar to non-competes in that their enforceability depends on their reasonableness in scope. A common use of non-solicitation agreements is to prevent employees from raiding a former employer’s workforce. The enforceability of these agreements depends on a few factors, most importantly, how, where, and for how long a non-solicitation clause is agreed upon. A non-solicitation clause restricting doctors from soliciting their patients or manipulating them with personal offers is much more likely to be found enforceable than a clause with broader restrictions.
Practical Tips for Employers and Employees
Practical advice for employers includes considering the breadth of the geographical scope, if any. In most circumstances, statewide is considered too broad in the employment context, even for large companies. The additional costs for a company to have two non-competes, one for employees in Texas and one for those outside of Texas, is usually insignificant, especially when compared to the enforcement considerations. If you have employees that travel for work, consider having non-compete agreements that differ from those with non-traveling employees.
Practical advice for employees includes the following: If your employer presents you with a non-compete agreement, don’t sign it , at least not at that time. Take it home and read it and think about its implications. Ask friends that are knowledgeable about these issues and who are not part of your decision-making chain to read it and comment about it. Speak to an attorney that has experience drafting and enforcing non-competes before signing. Consider the possibility that the opportunity may go away. Speak to your spouse and discuss what this means for you both. Make sure you understand what result enters into the law suit that followed a violation of the non-compete agreement.
In negotiating the scope of the non-compete, representatives of both sides should be aware of the nature, scope, and possible centralization of the business. Perhaps no non-compete is necessary and a properly drafted confidentiality agreement will suffice. Maybe the non-compete should differ depending on the nature of the employees’ role in the business.