Shift in the Law Means It's Time to Review Nonsolicitation Covenants

Shift in the Law Means It's Time to Review Nonsolicitation Covenants

There is an apparent shift in Texas regarding employees’ nonsolicitation covenants. A recent example is an opinion from Fort Worth’s Second Court of Appeals, which relied on Texas’ Covenant Not to Compete Act (the CNCA) to determine the enforceability of a former employee’s covenant to not solicit her former employer’s employees. That approach may come as a surprise to lawyers who thought simple breach of contract principles governed such covenants. In-house counsel should begin to think through that approach’s potential impact on their workforces.

Covenants not to solicit are related to covenants not to compete with a previous employer. Texas considers covenants not to compete to be disfavored restraints on trade.

But what is a covenant not to compete, and how does the law define it? Curiously, the CNCA (at Business and Commerce Code §15.50) launches into a statement of when covenants not to compete are enforceable, but the statute fails to define such covenants.

Courts have not particularly worried over the definition of a covenant not to compete, taking the approach that judges know them when they see them. A traditional covenant not to compete typically contains limitations on competitive activity with a former employer with limits regarding time, geography and scope of activity.

In that vein, Texas courts generally treat covenants not to solicit customers the same as covenants not to compete. Covenants not to solicit customers often contain a geographic limitation and receive analysis under the CNCA.

But what about prohibitions on soliciting former employees after an employee leaves her former employer? In our experience, courts have not traditionally used the analysis in §15.50 to determine enforceability. Instead, courts often used simple breach of contract principles as a rule of analysis, particularly considering when injunctive relief is appropriate.

The Second Court’s opinion in Ally Financial Inc. v. Gutierrez, which relies on previous case law, shows a shift in that approach. According to the appellate court’s opinion, Sandra Gutierrez worked for Ally Financial Inc., which originated and sold mortgages. She was an IT leader in Ally’s Lewisville office. She supervised 89 information technology employees and was responsible for all aspects of the IT department’s operations.

She participated in Ally’s long-term equity compensation incentive plan, which contained a nonsolicitation covenant. One portion of that covenant prohibited her from soliciting or employing Ally employees for two years after she left Ally.

Eventually, Gutierrez left Ally and went to work for a competitor as its chief technology officer. Some of Ally’s employees joined Gutierrez at her new employer. The employee turnover to a competitor led Ally to sue Gutierrez and her new employer. The trial court granted the defendants’ summary judgment motions on all of Ally’s claims; Ally appealed, and the appellate court affirmed.

Enforceability

The appellate court analyzed Gutierrez’s contractual promise not to solicit employees. Ally argued that the nonsolicitation covenant’s enforceability was not determined under §15.50. The appellate court explained—in footnotes and in its analysis of the covenant’s reasonableness—that §15.50 applies to nonsolicitation covenants, which must “contain reasonable limitations as to time, geographical area, and scope of activity to be restrained.”

The court also stated that courts first need to determine whether “the covenant is part of an otherwise valid agreement and that the covenant is ancillary to that agreement.”

For support, the appellate court cited Marsh USA Inc. v. Cook, a 2011 Texas Supreme Court opinion. In Marsh, the high court wrote that “[c]ovenants that place limits on former employees’ professional mobility or restrict their solicitation of the former employers’ customers and employees are restraints on trade and are governed by the Act.” The departing employee in that case allegedly solicited former customers.

Marsh is a seminal case because the high court held that an employer’s stock options award to its employee, and subsequent exercise by that employee, was sufficient consideration to enforce a nonsolicitation of customers covenant under the CNCA. The former employer’s suit was not focused on the relevant agreement’s prohibition on recruiting former co-workers.

The Ally Financial court cited Marsh to hold that a covenant not to solicit employees—just like covenants not to solicit customers—is analyzed under the CNCA. The Ally Financial court also cited other cases that determined the enforceability of noncompetition agreements.

The court also determined that 14,000 Ally employees were located across the nation, some in foreign countries. Those employees and other former employees were included in the scope of Gutierrez’s nonsolicitation covenant. Thus, the court concluded that the “covenant goes beyond what was necessary to protect Ally’s goodwill or other business interests of Ally.” Accordingly, the appellate court held that the nonsolicitation covenant was unreasonable in scope and thus unenforceable.

Lawyers have to wait and see whether other courts will adopt the Ally Financial court’s view that the CNCA, Marsh and case law determining the enforceability of noncompetition covenants alsogovern covenants not to solicit employees. Lawyers—especially those with previously held beliefs that the CNCA does not govern covenants not to solicit employees—should carefully review the Ally Financial court’s approach in departing employee matters.

Mark Shank is a partner in and Greg McAllister is an associate with Gruber Hurst Johansen Hail Shank in Dallas. Shank is an adjunct professor at Southern Methodist University Dedman School of Law. Their email addresses are mshank@ghjhlaw.com and gmcallister@ghjhlaw.com.

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