Noncompetition Agreement.
Noncompetition Agreement. (Shutterstock)

“Litigation over agreements not to compete after the termination of employment has long been a staple of business litigation.” Michael Quinn & Andrea Levin, Post Employment Agreements Not to Compete: a Texas Odyssey, 33 Tex. J. of Bus. L. 7, 9 (Spring 1996). In Texas, the enforceability of noncompetition agreements (“noncompetes”) has widely varied. By the end of the 1980s, noncompetes were highly disfavored by Texas courts. The Texas Legislature responded with the Texas Covenants Not to Compete Act. (Tex. Bus. & Com. Code § 15.50-52), which was intended to favor noncompetes. That act required enforcement of noncompetes so long as they are: (1) ancillary to an otherwise enforceable agreement, (2) serve a legitimate business purpose, and (3) contain reasonable limits as to time, and geography and scope of activity restricted.

In the Texas Supreme Court’s 1994 Light v. Centel Cellular decision, however, the court retained a large degree of the traditional judicial hostility to noncompetes. The year 2006 witnessed the beginning of a sea change regarding the enforceability of noncompetes. In Alex Sheshunoff Management Services v. Johnson, the Supreme Court gave heed to the legislative directive favoring the enforcement of reasonable noncompetition agreements. Sheshunoff found that a mere promise to give training and confidential information in the future supported the noncompete provisions in an otherwise valid employment agreement.

In 2009, the Texas Supreme Court expanded this holding in Mann Frankfort Stein & Lipp Advisors v. Fielding. There the court held that an implicit understanding that confidential information would necessarily be provided to an employee supported the enforceability of a noncompete. In 2011, the court’s Marsh USA v. Cook decision upheld a noncompete provision in a stock option plan, without requiring even an implicit agreement to provide confidential information or specialized training in the future.

The Texas Supreme Court’s march in favor of expanded enforcement of noncompetes most recently culminated in its 2014 Exxon Mobil v. Drennen decision. In Drennen, a high-level executive’s restricted stock agreement contained a “claw back” provision under which the stock would fail to vest if the employee left the company and engaged in “detrimental activity,” which included working for a competitor. This case had an interesting twist in that it contained a New York choice of law provision. Since its 1990 DeSantis v. Wackenhut decision, the Texas Supreme Court had consistently refused to honor foreign forum choice of law provisions in noncompete agreements on public policy grounds.

The Drennen court first found that a stock forfeiture provision was not a noncompete, even though its effect was to forfeit millions of dollars in stock awards when a former executive joined a competitor. The Court applied New York law and upheld the forfeiture provision.

The Drennen decision is somewhat puzzling. There does not seem to be a clear dividing line between the stock-related incentive programs in Marsh and in Drennen. Both involved the loss of valuable stock rights for joining a competitor. Further, the Drennen decision left major questions unanswered. First, the court stated that it was not setting forth a test to determine what makes an agreement a “noncompetition” agreement governed by the Covenant Not to Compete Act. The court merely said a “forfeiture clauses in noncontributory profit sharing plans … clearly are not covenants not to compete.” In reaching this conclusion, the court seemed to call DeSantis itself into question. The Drennen decision noted that times have changed since the DeSantis decision and that Texas may have a greater public policy interest in protecting the interests of Texas-based multistate corporations seeking uniformity in the interpretation of its agreements. Second, the court stated that, since it was applying New York law, it was not deciding whether a forfeiture clause such as this would be void as an unreasonable restraint of trade under Texas law.

Although the foregoing cases represent a major shift in favor of noncompetes, they did not alter the traditional requirement than noncompetes contain reasonable, time, geography and scope limitations. Generally, provisions limited to one to two years post-employment have been found reasonable. In the sale of a business context, courts have upheld even longer noncompetition periods, e.g, five to seven years for the selling owners.

Similarly, courts continue to require that the geographic area and scope of activity of noncompetes be reasonable. Once again, the total failure to limit the geographic scope of an agreement is typically fatal. A number of cases have recognized that the geographic territory in which an employee worked for the former employer is presumably reasonable. In the context of a customer nonsolicitation provision, courts have held that no geographic restriction is necessary in light of the restriction to specific customers, which serves as an alternate to a geographic limitation. The scope of occupations precluded should also be reasonably limited to those performed at the prior job.

If requested and supported by appropriate evidence, courts may reform an overbroad noncompete and enforce as reformed. Such reformation, however, precludes the award of attorney fees for conduct preceding the reformation.

Finally, a word of caution. While the Supreme Court now views noncompetition agreements more favorably, trial courts still scrutinize them carefully and will strike them down if they seem heavy-handed. The Supreme Court has emphasized that proponents of such agreements must show a legitimate business purpose for the restraint of trade implicit in such agreements. Imposing noncompetes on low-level employees or trying to stretch their time, geographic area, and scope of occupation to their outer limits can easily backfire. Remember: “pigs get fat and hogs get slaughtered.”

“Litigation over agreements not to compete after the termination of employment has long been a staple of business litigation.” Michael Quinn & Andrea Levin, Post Employment Agreements Not to Compete: a Texas Odyssey, 33 Tex. J. of Bus. L. 7, 9 (Spring 1996). In Texas, the enforceability of noncompetition agreements (“noncompetes”) has widely varied. By the end of the 1980s, noncompetes were highly disfavored by Texas courts. The Texas Legislature responded with the Texas Covenants Not to Compete Act. ( Tex. Bus. & Com. Code § 15.50-52 ), which was intended to favor noncompetes. That act required enforcement of noncompetes so long as they are: (1) ancillary to an otherwise enforceable agreement, (2) serve a legitimate business purpose, and (3) contain reasonable limits as to time, and geography and scope of activity restricted.

In the Texas Supreme Court’s 1994 Light v. Centel Cellular decision, however, the court retained a large degree of the traditional judicial hostility to noncompetes. The year 2006 witnessed the beginning of a sea change regarding the enforceability of noncompetes. In Alex Sheshunoff Management Services v. Johnson, the Supreme Court gave heed to the legislative directive favoring the enforcement of reasonable noncompetition agreements. Sheshunoff found that a mere promise to give training and confidential information in the future supported the noncompete provisions in an otherwise valid employment agreement.

In 2009, the Texas Supreme Court expanded this holding in Mann Frankfort Stein & Lipp Advisors v. Fielding. There the court held that an implicit understanding that confidential information would necessarily be provided to an employee supported the enforceability of a noncompete. In 2011, the court’s Marsh USA v. Cook decision upheld a noncompete provision in a stock option plan, without requiring even an implicit agreement to provide confidential information or specialized training in the future.

The Texas Supreme Court’s march in favor of expanded enforcement of noncompetes most recently culminated in its 2014 Exxon Mobil v. Drennen decision. In Drennen, a high-level executive’s restricted stock agreement contained a “claw back” provision under which the stock would fail to vest if the employee left the company and engaged in “detrimental activity,” which included working for a competitor. This case had an interesting twist in that it contained a New York choice of law provision. Since its 1990 DeSantis v. Wackenhut decision, the Texas Supreme Court had consistently refused to honor foreign forum choice of law provisions in noncompete agreements on public policy grounds.

The Drennen court first found that a stock forfeiture provision was not a noncompete, even though its effect was to forfeit millions of dollars in stock awards when a former executive joined a competitor. The Court applied New York law and upheld the forfeiture provision.

The Drennen decision is somewhat puzzling. There does not seem to be a clear dividing line between the stock-related incentive programs in Marsh and in Drennen. Both involved the loss of valuable stock rights for joining a competitor. Further, the Drennen decision left major questions unanswered. First, the court stated that it was not setting forth a test to determine what makes an agreement a “noncompetition” agreement governed by the Covenant Not to Compete Act. The court merely said a “forfeiture clauses in noncontributory profit sharing plans … clearly are not covenants not to compete.” In reaching this conclusion, the court seemed to call DeSantis itself into question. The Drennen decision noted that times have changed since the DeSantis decision and that Texas may have a greater public policy interest in protecting the interests of Texas-based multistate corporations seeking uniformity in the interpretation of its agreements. Second, the court stated that, since it was applying New York law, it was not deciding whether a forfeiture clause such as this would be void as an unreasonable restraint of trade under Texas law.

Although the foregoing cases represent a major shift in favor of noncompetes, they did not alter the traditional requirement than noncompetes contain reasonable, time, geography and scope limitations. Generally, provisions limited to one to two years post-employment have been found reasonable. In the sale of a business context, courts have upheld even longer noncompetition periods, e.g, five to seven years for the selling owners.

Similarly, courts continue to require that the geographic area and scope of activity of noncompetes be reasonable. Once again, the total failure to limit the geographic scope of an agreement is typically fatal. A number of cases have recognized that the geographic territory in which an employee worked for the former employer is presumably reasonable. In the context of a customer nonsolicitation provision, courts have held that no geographic restriction is necessary in light of the restriction to specific customers, which serves as an alternate to a geographic limitation. The scope of occupations precluded should also be reasonably limited to those performed at the prior job.

If requested and supported by appropriate evidence, courts may reform an overbroad noncompete and enforce as reformed. Such reformation, however, precludes the award of attorney fees for conduct preceding the reformation.

Finally, a word of caution. While the Supreme Court now views noncompetition agreements more favorably, trial courts still scrutinize them carefully and will strike them down if they seem heavy-handed. The Supreme Court has emphasized that proponents of such agreements must show a legitimate business purpose for the restraint of trade implicit in such agreements. Imposing noncompetes on low-level employees or trying to stretch their time, geographic area, and scope of occupation to their outer limits can easily backfire. Remember: “pigs get fat and hogs get slaughtered.”