- posted: Oct. 01, 2014
- Recent Developments 2014
On August 29, 2014, the Texas Supreme Court issued its decision in Exxon Corp. v. Drennen, holding that New York law governed the enforceability of a non-compete in the context of the forfeiture of an employee’s stock options. The Texas Supreme Court held that, when the only penalty is the forfeiture of stock options, the non-compete is not really a non-compete because it did not prevent the employee from working. The court held that a forfeiture clause did not raise any fundamental public policy concerns that would affect a choice of law analysis. Drennen is discussed here.
Less than a month later, the First Court of Appeals dealt with a similar fact pattern in Cameron International Corp. v. Guillory, No. 01-14-00452-CV (Tex. App. – Houston [1st Dist.] Sept. 25, 2014). The court’s analysis reveals the potential for confusion in the post-Drennen environment.
Up to a certain point, the facts of the two cases are identical. In both cases, the employer had granted stock options to an employee. In both cases, the stock options were subject to a non-compete if the employee left the company. In both cases, the stock option agreements provided for the application of non-Texas law (New York in Drennen, Delaware in Guillory). In both cases, the employee left the company and went to work for a competitor.
However, there were three significant differences:
1. The employee in Drennen was a Texas resident, while the employee in Guillory was a Colorado resident. This means that the non-compete raised public policy considerations under Colorado law, not Texas law.
2. The employer in Drennen sought only forfeiture of the stock options, while the employer in Guillory sought an injunction to enforce the non-compete. This means that, under the reasoning of Drennen, the full range of public policy considerations for non-competes are applicable.
3. In fact, Guillory was an appeal by the employer from the denial of a temporary injunction to enforce the non-compete. In other words, the employer in Guillory was seeking to stop the employee from working.
The First Court of Appeals did not directly address these issues. Instead, the court simply held that Texas had no overriding interest in the enforceability of the non-compete, and therefore the Delaware choice of law clause should apply.
Texas has no overriding interest in protecting an employment relationship between a multinational corporation and a resident of another state. “The drafters of the Restatement explained the rationale for section 187 by stating that ‘[p]rime objectives of contract law are to protect the justified expectations of the parties and to make it possible for them to foretell with accuracy what will be their rights and liabilities.’” Because Texas has no materially greater interest in this dispute, we hold that the trial court was required to apply Delaware law as specified in the parties’ agreement in determining whether Cameron demonstrated a probable right to relief. (citation omitted).
Applying Delaware law, the Court held that the non-compete was enforceable and reversed the denial of the temporary injunction.
This decision raises several important questions:
1. Why was the court focused on Texas law vs. Delaware law? The correct choice of law analysis should have focused on Colorado law vs. Delaware law. Given that Colorado is known as a state that does not favor non-competes, the employee might have been expected to be arguing for the application of Colorado law. While Texas may have had little or no interest in the enforceability of the non-compete, Colorado had a significant interest in whether one of its residents could be enjoined from working in Colorado. The answer to this question lies in the fact that a Colorado statute specifically authorizes non-competes for executives such as the employee in Guillory. As a result, the employee wanted to avoid discussion of Colorado law, and in fact it was the employer who discussed Colorado law in the briefing. Just the same, the First Court of Appeals' analysis does not mention Colorado law and thus may create the erroneous impression that only Texas law is at issue in these sorts of cases.
2. The court suggests that Drennen overruled prior case law which held that non-competes implicate fundamental public policies, because times have changed and public policy considerations change with the times. But is that correct? The Supreme Court stressed the fact that the forfeiture clause was not a non-compete. For example, the Supreme Court stated the following in a footnote:
We recognize that other jurisdictions have held, as we did in DeSantis, that the application of another state’s law which results in the enforcement of a non-competition agreement contravenes the forum state’s fundamental public policy. [Citing numerous cases] However, once again, it should be noted that this case does not involve a covenant not to compete. See discussion infra.
The First Court of Appeals appears to have reached a different conclusion, and that may or may not have been correct. This may create confusion in future cases.
3. The analysis in Drennen proceeded from the proposition that the forfeiture clause in that case was not a non-compete because it did not prevent the employee from working. The First Court of Appeals applied the Drennen logic to a case in which the employer was trying to prevent the employee from working. Is the Drennen analysis really applicable in that situation?
4. Can an employer get away with enforcing a forfeiture of stock options and seeking an injunction? At some point, the total scope of the restraint may exceed the bounds of reasonableness, and for that matter the employer’s position may be subject to challenge as a restraint on trade or an illegal penalty.
David C. Holmes is a Houston employment lawyer with The Law Offices of David C. Holmes