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Non-Competition Agreements: What’s New and Are They Right for your Business?
From Texas Business Today, a publication of the Texas Workforce Commission, this article points out the basic points to remember in Non-Compete Agreements. While written for employers, the main ideas are the same for a Non-Compete entered into by a business seller.
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It is fairly common to hear employers on our Employer Hotline tell us that a valued employee has left the company and has now opened shop across town and is competing with the employer. The former employee has not only taken the employer’s customers, but also his or her business. Many Texas employers who call our Employer Hotline often ask whether a non-competition agreement can be enforced against such a former employee. Usually, the answer is, “it depends,” and when it comes down to non-competition agreements in Texas, it depends on various issues. In order to understand Texas’ non-competition agreement laws, we must dissect the Texas statute that governs such agreements. In 1989, the Texas Legislature enacted section 15.50(a) of the Texas Business & Commerce Code which states the requirements that make a non-competition agreement enforceable.
Legal Requirements for a Non-Competition Agreement
Section 15.50 of the Texas Business & Commerce Code requires that a non-competition covenant (1) be “ancillary to or part of an otherwise enforceable agreement at the time the agreement is made;” (2) impose “limitations as to the time, geographical area, and scope of activity to be restrained that are reasonable;” and (3) not “impose a greater restraint than is necessary to protect the goodwill or other business interest” of the former employer.
Ancillary To An Otherwise Enforceable Agreement
The first part of the statute requires that the employee’s promise not to compete be “ancillary to or part of” a related or underlying contract imposing binding obligations on the employee and the employer. In other words, a covenant not to compete is “ancillary to or part of” an otherwise enforceable agreement if: 1) the consideration given by the employer in that agreement gives rise to the employer’s interest in restraining the employee from competing and 2) the covenant is designed to enforce the employee’s consideration or return promise in that agreement [see Light v. Centel Cellular Co. 883 S.W.2d 642 (Tex. 1994)]. I know, you are thinking: can you please explain this to me in plain English?
To begin, there has to be “consideration,” which in contract law is generally anything of value promised to another for signing a contract. For example, A signs a contract to buy a car from B for $5,000; A’s consideration is $5,000 and B’s consideration is the car. Therefore, the employer cannot have the employee sign a non-competition agreement and promise the employee additional compensation in return for a non-compete agreement because after all, the employee, by working, will be compensated in any event. Texas employers cannot “buy” a non-compete agreement [see Trilogy Software, Inc., v. Callidus Software Inc., 143 S.W.3d 452 (Tex. App. – Austin 2004, pet. filed)]. However, stay tuned to see what the Texas Supreme Court decides on Marsh USA, Inc. vs. Cook, because Marsh may allow employers to give money in exchange for an agreement not to compete, which may make such agreements easier to enforce. In addition, the promise given in the underlying agreement must give rise to the employer’s interest in preventing the employee from competing. In other words, whatever the employer promises to give to the employee (e.g., employer promises employee proprietary information) in exchange for what the employer wants the employee to promise (e.g., employee promises not to compete) needs to be in the employer’s interest. For example, proprietary information is consideration that, like the court in Light stated, “gives rise to the employer’s interest in restraining the employee from competing.” Therefore, it is in the employer’s interest to keep the employee from competing when it gives an employee proprietary information. The court in Light gave “business goodwill”, “proprietary information”, and “confidential information” as examples of employer interests worthy of protection.
You are probably thinking: What is considered “proprietary information or confidential information?” In a 2009 case called Gallagher Health Insurance Services v. Vogelsang, 312 S.W.3d 640 (Tex. App.-Houston [1st Dist.] August 21, 2009, pet. filed), the court enforced a two-year non-compete agreement that Ms. Vogelsang, an insurance broker, had signed acknowledging she would receive different types of confidential information such as: confidential client information, pricing of special insurance packages, and information concerning the customers’ policies. Ms. Vogelsang had left her position at Gallagher Health Insurance Services (GHIS) to work for a competitor and she argued that the information she had obtained while working for GHIS was not confidential information because it could have been obtained from public sources. The company argued that the information took two years to acquire; 2) was only shared with the company’s employees and agents on a “need to know” basis; 3) was not “readily ascertainable by competitors;” and 4) gave the company a “valuable competitive advantage in the insurance brokerage industry.” The court found that the not-to-compete covenant was enforceable because Ms. Vogelsang had signed and agreed not to compete against GHIS in exchange for GHIS’s promise to provide her with confidential information. However, Justice Jennings disagreed with the rest of the court, stating in the dissenting opinion that just because GHIS’s information was only provided on a “need to know basis” did not make it worthy of protection and GHIS did not demonstrate that its customers’ identities could not be easily obtained by others outside of GHIS. In other words, Justice Jennings believed GHIS failed to show that its customers’ information was confidential, which brings us to the next question: Can a non-compete agreement be enforced when a former employee is taking his or her former employer’s customers? The answer: maybe.
Texas courts focus on whether the identities of those customers are confidential. Whether customer identities are confidential depends on whether their information can be easily found, for example, in telephone books, or if the employer took reasonable steps to keep the customers’ information confidential. For example, in a Texas Supreme Court case called DeSantis v. Wackenhut Corporation, 793 S.W.2d 670 (Tex. 1990), the court found that the employer, a company that specialized in furnishing security guards for businesses throughout the United States, failed to prove that its “customers could not readily be identified by someone outside its employ, that such knowledge carried some competitive advantage, or that its customers’ needs could not be ascertained simply by inquiry addressed to those customers themselves.” The employer had tried to argue that it had provided Mr. DeSantis confidential information (i.e., identities of Wackenhut’s customers, and the customers’ special needs and requirements); therefore, Mr. DeSantis should be prevented from competing with the employer. However, the court thought otherwise. Arguably, the “he’s stealing my customers” defense may not be an employer interest worthy of protection. In addition, the court in also opposed the employer because the employer’s need for protection afforded by the agreement not to compete was unduly burdensome on the employee, because, after all, the employer was preventing the employee from having a livelihood.
While Texas courts look at whether the customers’ identities are confidential, they also seem to look at the former employee’s position. For example, in M-I LLC v. Stelly, Civil Action No. 4:09-cv-1552, 2010 WL 3257972 (S.D. Tex. Aug. 17, 2010), the court agreed with the employer’s non-competition agreement, which prevented the employee from contacting all of the former employer’s customers, including the customers the employee dealt with while working for the former employer. One of the factors the court looked at when determining the enforceability of the agreement was the upper management position held by the employee. The employer provided evidence showing that the employee was much “more than a manager and salesman.” For example, the employer proved that the employee had relationships with “major international clients” and “participated in the design of the employer’s tools” and “formulated company growth strategies and discussed product development with engineers.” The court also found that the employee did have “sensitive information” and “intimate knowledge of tool designs and functionality” which was an interest worthy of protection and therefore, the court enforced the non-compete agreement which restricted the employee from all customer contact. Usually, in the context of sales employees, “a covenant not to compete that extends to clients with whom a salesman had no dealings” (i.e., customers the former employee never dealt with while working for the former employer) is unenforceable (see Wright v. Sport Supply Group, Inc., 137 S.W. 3d 289 – Tex. App.-Beaumont 2004, no pet.). It is evident that the enforcement of a Texas non-competition agreement can vary from case to case.
Reasonable Time Limitations
Section 15.50 of the Texas Business Code also requires a non-competition agreement to contain a reasonable time limitation as to how long the employee is restrained from competing. Texas courts have upheld two to five years as reasonable in a non-competition agreement [see Stone v. Griffin Comm. & Security Systems, Inc., 53 S.W.3d 687 (Tex. App.-Tyler 2001, no pet.)]. So, will the time limitation be “reasonable” under the law if an employer picks any number between 2 and 5? No, not necessarily. The employer’s reason for the time period will usually be balanced with the hardship the employee has to face (i.e., not being able to work). For example, in Alex Sheshunoff Mgmt Servs. L.P. v. Johnson 209 S.W.3d 644 (Tex. 2006), the Texas Supreme Court held that the non-competition agreement was reasonable in that the employee could not contact any clients or prospective clients for one year because he was a high-level employee and could not have otherwise capitalized on goodwill that he helped develop during his time with the former employer. Alex Sheshunoff Management Services, L.P., a company that provides consulting services to banks and other financial institutions, promoted Mr. Johnson to director of its Affiliation Program where he was to maintain relationships with current and prospective clients. Mr. Johnson left Sheshunoff to work for a competitor, and Sheshunoff argued that Mr. Johnson had been given confidential information and specialized training and in return had promised (i.e., he signed the non-competition agreement) not to “solicit or aid any other party in soliciting any affiliation member or previously identified prospective client or affiliation member.” Sheshunoff provided evidence that Mr. Johnson had participated in confidential meetings regarding the company’s “plans to introduce a bank overdraft protection product” and had received an “internal manual on this new product.” The court took into account the “amount of information” Mr. Johnson received, “its importance, its true degree of confidentiality, and the time period” over which it was received. At the end, the court found it reasonable to prevent Mr. Johnson from contacting Sheshunoff’s clients or prospective clients for one year, which meant that Mr. Johnson could not work for the competitor that had hired him. As you can see the time limitation has to be reasonable, but what is “reasonable” depends on all the facts and how the court analyzes those facts. However, an indefinite amount of time is unenforceable, so employers should be sure to insert a specific time limit in a non-competition agreement.
Reasonable Geographical Limitations
In addition to a time limitation, a geographical limitation is required in a non-competition agreement. A “reasonable geographic scope is generally considered to be the territory in which the employee worked for the employer.” [see Butler v. Arrow Mirror and Glass, Inc. 51 S.W.3d 787(Tex. App.-Houston [1st Dist.] 2001, no pet.)]. However, just because an employer may not want a former employee to work within, for example, a 20-mile radius, which the employer considers the territory the employee worked in, does not mean that such an agreement would be enforceable. Every case’s outcome will depend on the facts. For example, in Cukjati v. Burkett 772 S.W.2d,(Tex. App.-Dallas 1989, no writ), the court found that because most pet owners travel a few miles to obtain veterinary services for their pets, a covenant not to compete which restrained a former employee from practicing anywhere within a 12-mile radius of the employer’s veterinary hospital was considered unreasonable.
Texas courts also have refused to enforce non-competition agreements with nationwide limitations when the employee did not have nationwide responsibilities for the former employer. However, in a case called Curtis v. Ziff Energy Group, Ltd., 12 S.W.3d 114 (Tex. App-Houston [14th Dist.] 1999, no pet.), the court agreed with the employer in holding that based on the employee’s job description and responsibilities, it was reasonable to keep the employee from working in other oil and gas consulting firms in North America. In Curtis, the former employee worked as the Vice President of Pipelines and Energy Marketing, and the covenant not to compete barred the employee from participating in competitive business in Canada or the United States. The court agreed with the employer in that it was reasonable to restrict the employee from working for 20 oil and gas consulting firms in North America (i.e., specific firms the employer listed). The court stated that given the employee’s high-ranking position and the unique aspects of the industry involved, just like we saw in M-I LCC v. Stelly, it was reasonable to restrict the former employee from working for certain companies in North America.
Therefore, it seems as though a Texas employer can have a non-compete agreement that prevents a former employee from competing for certain companies in North America. However, does this mean you can restrict, for example, a former administrative assistant from working anywhere in the United States? Probably not, but then again it depends on the facts of the case.
Reasonable Limitations on Scope of Activity
A reasonable restriction on the scope of activity can be a substitute for failing to include a geographical restriction in a non-competition agreement. For example, as we saw in Sheshunoff, the covenant prohibited the employee from providing services to the employer’s clients for a period of one year after the employee separated from the employer. In other words, while the non-competition agreement did not include a geographical limitation (e.g., 20-mile radius), the court still found the agreement enforceable because it included a reasonable limit on the former employee’s activities (i.e., the former employee could not contact any of the employer’s clients).
Generally, like the previous two requirements, this requirement is enforceable if the court decides that the restraint is tailored to match the employer’s protectable interest. For example, in Sheshunoff, it was reasonable to restrain the former employee from contacting the employer’s clients, since the former employee did obtain sensitive information which the court considered a protectable employer interest, and the information could affect the employer if obtained by a competitor.
In all, enforcing a non-competition agreement is more difficult than one may think. For example, keep in mind that merely having the employee’s signature does not automatically enforce what is in the agreement. One must seek legal representation and have a court rule that the agreement is enforceable which takes time and money.
Here are three basic points to consider when contemplating the creation of a non-competition agreement:
1. Reasonableness: Remember that the agreement has to protect a legitimate business interest without unduly burdening the employee from finding a job.
2. Exchange for Something: Consideration must be present on both sides. The employer and employee have to “give up” something.
3. Time, Geographic Limitations, and Scope of Activity: Be specific and as reasonable as possible when setting these limitations.
For creating an enforceable non-competition agreement, it is always best to consult with an attorney.
–Marissa Marquez, Legal Counsel for Chairman Tom Pauken
