- posted: Mar. 22, 2013
In many states, an employer will have great difficulty enforcing a covenant not to compete. In fact, in some states, non-competes are contrary to public policy and are never enforceable (or are enforceable only in specific circumstances such as the sale of a business).
Texas is not one of those states. Texas law will enforce a non-compete under appropriate circumstances. This is a simple guide to non-competes under Texas law.
1. Why are non-competes so controversial?
If a non-compete is enforced, the employee may be unable to find a job in the employee’s chosen profession. When coupled with the at-will employment rule, this means that an employee who signs a non-compete (a) can be fired for any reason, and (b) can be prevented from getting a new job in the same business. An employee is supposed to be able to quit his or her job at will, but a non-compete allows the employer to exercise control over former employees.
The flipside is that employers may have legitimate reasons for preventing employees from going to work for competitors, such as the protection of goodwill and trade secrets. While Texas law allows the enforcement of non-competes under appropriate circumstances, both the courts and the legislature have been wary of allowing the abuse of non-competes.
There are two lessons to be drawn from this:
1. Employers must be aware that non-competes will be subject to strict scrutiny by the courts. It is important that non-competes be carefully drafted and that employers be prepared to justify the restrictions imposed by the non-competes.
2. Employees must be very cautious about signing non-competes. If things go sour at the company, the employee may be unable to find a job or able to find only jobs at a much lower pay scale. Non-competes will usually be presented on a “sign this or you are fired” basis. For some employees, the wise choice may be to say no.
2. What is the Texas statute governing non-competes?
In 1989, the Texas legislature enacted section 15.50 of the Texas Business and Commerce Code. Section 15.50(a) states:
[A] covenant not to compete is enforceable if it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made to the extent that it contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee.
For over two decades, the courts have wrestled with the peculiar language of the phrase “if it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made.” What is “an otherwise enforceable agreement”? When is a non-compete “ancillary to” another agreement? What does it mean to be ancillary to another agreement “at the time the agreement is made”? At times, the court decisions interpreting those phrases have been difficult for anyone to understand or apply.
In recent years, the Texas Supreme Court moved away from the interpretation of the specific words in the statute and has adopted a more pragmatic approach to analyzing non-competes.
3. When will the Texas courts enforce a non-compete?
The most recent Texas Supreme Court decisions seem to endorse a two-step analysis for non-competes.
First, the court should determine whether the circumstances justify the imposition of a non-compete obligation. In other words, does the employer have a sound justification for requiring the employee to sign a non-compete? This can be justified by the employee’s possession of trade secrets or confidential information, or the granting of stock options to the employee, or perhaps by other factors. However, a naked non-compete (in other words, a non-compete that serves no purpose other than restraining competition) will not be enforced.
Second, if the employer clears the first hurdle, the court should determine the reasonableness of the time, geographic area, and scope of activity set forth in the non-compete. If the court deems the non-compete to be excessively broad, the court can reform it to a reasonable scope.
4. When will the Texas courts find that a non-compete is justified?
There are no black and white rules here. In general, the courts are more likely to find that a non-compete is justified if the employee held a sensitive position with access to information that is vital to the employer. For example, the courts are likely to hold that a covenant not to compete is justified for a research scientist who has intimate knowledge of the employer’s proprietary technology and plans for future products. If such an employee went to work for a competitor, there would be a considerable danger that the secret information would be compromised.
Conversely, the courts are less likely to find that a non-compete is justified for ordinary employees performing common jobs. Some employers demand that every employee sign a non-compete, including retail salespeople, delivery drivers, office workers, and machinists. The courts are going to be skeptical of non-competes for those sorts of employees.
The battleground is often sales personnel. In some cases, sales personnel have intimate knowledge of secret information about pricing, the identity of key customers, the identity of key contacts within large corporate customers, and product information. However, in other cases, the employer simply wants to prevent a well known and well respected salesperson from going to work for a rival. These cases are highly dependent on the particular facts and circumstances.
5. What is a reasonable time for a non-compete?
An employer will want to make a non-compete last as long as possible, but the courts are often skeptical of non-competes that last more than one year. In appropriate cases, courts have enforced non-competes for two years or longer, but in other cases courts have limited non-competes to periods of less than one year. Again, this is highly dependent on the facts and circumstances. How much time is needed to protect the legitimate interests of the employer?
6. What is a reasonable geographic area for a non-compete?
This will depend on the nature of the employer’s business. If the employer is selling products in the Houston area, it will be hard to justify a non-compete that includes Austin, San Antonio, Dallas, and Beaumont. If the employer is selling products worldwide, it may be possible to justify a worldwide restriction. Likewise, if the employee holds a position that involves the development of technology, it may be possible to justify a restriction that goes beyond the company’s immediate business area if the employer can show a risk that the new employer would begin marketing products within the company’s business area.
7. What a reasonable restriction on the scope of activities for a non-compete?
This is sometimes the real battleground. Non-competes are often written so broadly that they would prevent an employee from going to work in a dissimilar business. For example, an employee that markets oilfield services equipment might insist on a non-compete that covers the entire oil industry, or a computer company might insist on a non-compete that covers the entire electronics industry. A non-compete might prevent the employee from going to work for a customer or a supplier of the employer. In these sorts of cases, the courts are likely to be skeptical about the scope of the non-compete.
8. How does an employer or an employee know whether a non-compete is likely to be enforced?
This can only be determined by looking at all of the facts and circumstances. It is important for both the employer and the employee to consult legal counsel before the non-compete is signed.
9. What happens if the court finds that the non-compete is overbroad?
In Texas, a court can reform or modify the non-compete to make it reasonable. If that happens, the employer cannot recover any damages based on conduct prior to the reformation. Furthermore, the court can order the employer to pay the employee’s attorneys’ fees if the court finds that the employer knew that the non-compete was overbroad.
10. What are the risks to the employer and the employee?
The risks to the employee are straightforward. The employer can file suit, seek a temporary restraining order followed by a temporary injunction, and eventually demand damages and attorneys’ fees. The employer can threaten the new employer or join the new employer to the lawsuit. Regardless of the outcome, the litigation is likely to be expensive and time consuming.
But the employer faces risks, too. The litigation will be expensive and time consuming for the employer. Furthermore, if the employer has carelessly imposed an obviously overbroad non-compete – which is not unusual – the employer may wind up paying the employee’s attorneys’ fees.
In most cases, the employer has the advantage of superior resources. However, if the new employer is sued, or chooses to support the employee, the former employer may find itself in for a long and expensive battle.
11. If the employee did not sign a non-compete, can the employer stop the employee from competing?
This can happen in two situations. First, an existing employee owes a fiduciary duty of loyalty to the employer. If an existing employee recruits customers or takes other actions that are inconsistent with the duty of loyalty, the employer may be able to sue for breach of fiduciary duties. It is important to remember that it is lawful for an existing employee to prepare to compete with the employer (such as making arrangements to open a new business after leaving the company). However, the employee cannot cross the line into actual competition.
Second, an employee cannot use the trade secrets of the former employer. In appropriate cases, this can extend to confidential information that does not rise to the level of a trade secret, especially if the employer has required the employee to sign a confidentiality agreement.
12. Are doctors treated differently?
Yes. Section 15.50(b) provides special rules that make it more difficult to enforce a non-compete against doctors. Among other things, a doctor has the right to buy out the non-compete.
David C. Holmes is a Houston employment lawyer with The Law Offices of David C. Holmes