What is a Covenant Not to Compete
A non-compete agreement is an agreement between an employer and an employee wherein the employee agrees not to engage in a business that competes with the employer or where the employer’s business interests are involved. A non-compete agreement can provide that the employee not become involved with a competing business for a specific period of time following termination of employment and/or that the employee avoid competition with the employer in a specific geographical area. The requirement that the employee leave the competing business may be in lieu of or in tandem with a prohibition on engaging in the competing business for a period of time.
Non-compete agreements are often more high profile than non-solicitation agreements . They might be associated with high-profile businesses such as software, manufacturing, or technology companies, or in the entertainment industries of film and television.
Because an employee’s future employment in many businesses is restricted, a non-compete agreement may sometimes be used in place of a severance package in order to separate a terminated employee from the company. The allocation of future employment opportunities away from the defendant can act as a substitute for typical "hush money" or "golden handcuff" arrangements. In this type of arrangement between the employer and the employee, in exchange for waiving the future employment restrictions, the employee would also be waiving his or her rights to payment under the non-competition agreement.
Covenant Not to Compete Law in Texas
Texas is known for its independent spirit and roguish traditions. One of those traditions that has been adopted by the person, as opposed to the government, is the use of noncompete agreements. Noncompete agreements or covenants not to compete are routinely entered into by all types of employees in Texas: doctors, lawyers, executive, salespeople, etc. Generally, they accomplish the same purpose. Specifically, the purpose is to prevent the former employee from soliciting customers and or working in a similar position with a competitor. But, not all noncompete agreements are created equal. In particular, some noncompetition agreements are heavily negotiated while others are presented on a "take it or leave it" basis. Perhaps more importantly, not all noncompete agreements are enforceable. On the contrary, the law in Texas generally prohibits the enforcement of overly broad noncompete agreements.
The legal framework for noncompetes in Texas is comprised of the Uniform Trade Secrets Act, Texas Business and Commerce Code § 15.50-15.52, the Texas Covenants Not to Compete Act, Texas Business and Commerce Code § 15.01-15.12, and related case law. The UTSA was enacted in 1979 and updated most recently in 2007. The law allows for an injunction or actual damages for the misappropriation of a trade secret. The UTSA is broader than traditional theft of trade secrets. For instance, it can be used for possession of a non-trade secret that is simply used to solicit business. This means that once a trade secret is discovered it cannot be used to work for a competitor. This is especially true for doctors who have to refer to other doctors to obtain referrals.
The Texas Covenants Not to Compete Act was adopted in 1989. It governs the enforceability of a noncompete in Texas. It applies to both contracts and covenants not to compete. Many employees in Texas don’t realize contracts and agreements are not the same thing. The law defines both terms pursuant to Tex. Bus. Comm. Code § 15.50(1)-(2). Notably, a covenant not to compete is a contract in restraint of trade or a contract not to compete. Under the statute, the elements of noncompetes, which are devoid of any exception, must be severable from those which are not contained in the law. Tex. Bus. Comm. Code § 15.50(3).
With regard to whether a noncompete is enforceable, the statute provides that a noncompete can be involuntarily dissolved under certain circumstances. The party attempting to dissolve the covenant bears the burden of proof. Tex. Bus. Comm. Code § 15.50(4)(a)-(b). More specifically, a noncompete is enforceable if: (1) it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made; and (2) it contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable necessary to protect the business interest sought to be protected by the promise. Tex. Bus. Comm. Code § 15.50(2). Noncompetes that do not satisfy the above are voidable. There is also a strong public policy in Texas prohibiting noncompetes from being overbroad. It is not unusual for Texas trial judges to modify or redraft covenants not to compete if they are overbroad. Even if the employer does not have the contract unenforceable, the judge may unilaterally modify the terms if they are unreasonable. Under this scenario, when the contract is modified and is no longer overbroad, the employer will recover attorney’s fees and costs. More notably, it is much more expensive to litigate a covenant not to compete where the judge modifies the terms than if the noncompete is not modified. For this reason, defendants-in-actions over noncompetes will almost always argue they are overbroad and request the judge modify their terms.
Texas Non-Competes are Enforceable
The enforceability of a covenant not to compete is generally subject to a same three-prong test for most covenants not to compete (referred to as "non-competition" agreements or provisions). The first prong is the need for a legitimate business interest that the employer seeks to protect. These interests can include trade secrets, confidential information, customer base, and (more recently) goodwill. The second prong of the test is that the non-compete must be for an appropriate time period. In Texas, the courts have upheld provisions not to compete for one to two years; however, five years is usually considered too long to find a legitimate business interest to protect. There are some instances where longer time periods were also upheld, but five years seen more often than not as outside the scope of reasonableness. The third prong of the test is that the non-compete must have an appropriate geographic scope. Texas courts have upheld nationwide and worldwide provisions when appropriate. For instance, a national real estate company may be able to seek to enforce its non-competition provision against its local agent throughout the country.
Texas Non-Competes are Voidable
Regardless of whether a non-competition agreement is contained within an employment agreement or independent contract, courts in Texas don’t always enforce these restraints. For example, a court has discretion not to enforce a non-compete when required to do so would contravene Texas public policy. In Amato v. Norris, the Texas Court of Appeals cited American Express Financial Advisors v. Mosser for the proposition that non-competes should not be enforced "if they contravene a well-recognized interest of public policy." 194 S.W.3d 255, 267 (Tex. App.—Houston [1st Dist.] 2006, no pet.). Even though courts are hesitant to disturb a party’s right to contract freely, courts will balance that right against other legitimate policies of the state. Id. at 267. An enforcement order may be denied if the court finds that it would eventually sanction illegal activity. Id.
Given Texas public policy favoring the broad enforceability of non-competes, the court in American Express Financial Advisors denied the former employer’s application for a temporary injunction when it determined that injunctive relief would grant the employer a windfall that would conflict with its fiduciary duty. Id. at 268. The injured employer would be able to take advantage of the same business information to which it initially had access while the employee and former client were still bound by the contract. Id. The Court, in refusing to enforce the non-compete agreements, reasoned that there are limits to the harm that an employer can sustain by having to wait until the expiration of the non-competition agreements before taking advantage of the business information that was previously in its control. Id.
Similarly, in Webb v. Shamrock Industries, Inc., the Texas Court of Appeals declined to enforce a 12-month non-compete restriction for an office manager who had unsupervised access to sensitive business information. 407 S.W.2d 5 (Tex. Civ. App.—Austin 1966, writ ref’d n.r.e.). The non-compete restricted Mr. Webb from competing in the scrap metal business in Johnson City, Texas, but the court’s opinion indicates that Mr. Webb was not allowed to compete in any city in any county in the State of Texas. Judgment was rendered that the non-competition covenant would not be enforceable. The Webb court made it clear that Mr. Webb’s "freedom to earn a livelihood is therefore forever curtailed by this non-compete agreement." Id. at 8. The Court declined to enforce the covenant and instead prospectively severed the non-competition restrictions to a valid duration of six months. Id. at 9.
Texas courts have also declined to enforce non-compete agreements because the restraint was unreasonable. An unreasonable restraint will not be enforced even when the parties agree on the duration, unless that agreement is placed in connection with otherwise valid consideration. S & T Oil Equipment, 267 S.W.3d at 30.
The addition of the non-competition restrictions did not make the otherwise invalid covenants enforceable in S & T Oil Equipment. Id. at 31. The non-competition provision was void because it did not protect "legitimate business interests" and it did not have a reasonable duration, geographical scope, and line of business so as to be enforceable as contracts among future employers. Id. The Court invalidated the attempted restraining covenant because S & T Oil’s former employees had worked for only 3 months in a single county in Texas. Id. at 31. The non-compete was not reasonably necessary to protect S & T Oil’s interests and it was too broad to be enforced because it restricted competition for an impermissibly long period of time and an undetermined geographic area. Id.
Thus, a court has discretion to refuse to enforce a non-compete where the restraint is unreasonably broad. Courts can also refuse to enforce a non-compete wholly or partially where required to do so would contradict Texas public policy. This discretion should be taken into account when drafting and analyzing non-compete agreements.
Examples of Court Decisions on Non-Competes
A review of Texas court cases reveals several examples of the legal challenges that can arise from non-compete agreements. In S & D Repurposed Murchison, Limited Partnership v. Patterson, 464 S.W.3d 834 (Tex. App.—Waco 2015)—a case originating in the Eastern District of Texas—an appeals court held that a non-compete agreement was unenforceable because an employee who had worked performing non-competitive tasks had never seen the trade secrets in question.
In that case, a packaging company, S&D Repurposed Murchison, sued its former bookkeeper, Gladys Patterson for breach of her non-compete and confidentiality obligations after she began working as an office manager for a new competitor. The new company argued that Patterson had not seen any of the purported trade secrets that constituted the competitive advantage of her former employer. The East Texas Regional Division of the United States District Court for the Eastern District of Texas agreed and held that the covenant was unenforceable against Patterson.
The Waco appeals court affirmed that decision, holding the non-compete was overbroad because "the undisputed evidence shows that Patterson never came into contact with Texas Paper’s trade secrets" and therefore, that S&D no longer employed Patterson or paid her salary, and "that Texas Paper never explained to Patterson the contents of its customer files . " The Waco appeals court did not, however, agree that Patterson had no knowledge of the customer or sales lists, since that knowledge was not necessarily learned solely in Texas. Overall, the court held that "there is no evidence that Patterson’s economic freedom has been restrained by the Covenant, but there is overwhelming evidence that Patterson is now free to exercise her trade without hindrance or fear of litigation."
A decision from the Eastern District of Texas more recently sided with a former employee who argued that their restraint, signed six years prior, was void because Abel is legally blind. Hewitt v. DSW, Inc., No. 4:20-CV-0040, 2020 WL 4960792 (E.D. Tex. June 4, 2020) involved a former employee of DSW who was offered a promotion on August 3, 2011. In order to receive the promotion and the accompanying higher compensation, DSW required their employee to sign a non-compete agreement. At the time, he did not have a lawyer review the agreement and worked for the company until September 7, 2016 when he resigned. In November 2016, he began working for their competitor, Intown. DSW sued DSW alleging that he breached his non-compete agreement. The court pointed out that DSW was likely to succeed on its claim, but nonetheless declined to grant a motion for a temporary restraining order and preliminary injunction based on the employee’s limited ability to review the agreement and the delay in filing the pleadings until almost four years passed between his departure from DSW in 2016 and DSW’s complaint in 2020.
How to Draft a Texas Non-Compete
Employers operating under the mistaken belief that a "canned" one-size-fits-all non-compete agreement is adequate for hiring employees will be left holding in their hands a very expensive and likely worthless document. And it may likely be worthless not only for that particular employee, but also for ALL of their employees.
Thus, employers should consider obtaining the assistance of qualified counsel to draft enforceable non-compete agreements that best fit their industry and business.
Texas courts have historically held that to be enforceable, a non-compete must be ancillary to an otherwise enforceable agreement where consideration is exchanged. While consideration is often easy to identify in the context of an employment relationship—namely, the opportunity for employment in exchange for the employee’s promise not to compete—it can also take other forms, including the sale of a business or the advancing of a loan. For example, a non-compete agreement is typically ancillary to an enforceable agreement where substantial limits exist before the employment relationship begins: But as for what limits an employer can impose on an employee’s activity during the employment relationship, there is a significantly different standard. According to Texas courts, a non-compete is not ancillary to an otherwise enforceable agreement if it simply constitutes a unilateral attempt by the employer to ‘protect its goodwill.’ The enforceability of the restrictions must be viewed with regard to whether the employer has appropriate economic justification just as in every other non-compete agreement.
A Texas non-compete should prohibit the employee from directly or indirectly: The non-compete should also include a definition of the "competitive activity" and the scope of the employee’s duties. For example, the agreement can accomplish the non-compete objective with some of the following: An expired employee is not as likely to recall with precision his former duties. Thus, the more detail the former employee has in the agreement, the more likely there will be a basis for evaluating whether the non-compete is being breached. A drafting attorney should seek to question the employee about his or her job responsibilities at the outset. This is not some afterthought to the employment interview process. As with any contract, the employee’s employment contract needs to be carefully drafted to set out all of the duties.
Rights and Remedies of Texas Employees
Employees who are working under the terms of a non-compete or other restrictive covenant should know that at all times that the restrictive covenant applies, they have a duty to comply with it. However, this also means that at all times they also have the power and the ability to challenge the validity and enforceability of the restrictive covenant as well.
In Texas, an employee who believes that a non-compete agreement is unreasonable or being enforced improperly has few options. Whether the employee has voluntarily resigned and is simply seeking to prosecute and collect damages or has an action pending for injunctive relief in the state court where the company has sued the employee to enforce the non-compete, he or she will be bound by the ruling made by the trial court on the issue. Almost all agreements will be considered valid and enforced unless the employee – or his lawyer – is able to prove otherwise. The basic standard is whether it is "expedient" for the employer to protect its interests by enforcement of the non-compete agreement. This is a very high standard to meet and most non-compete agreements will be presumed to be valid and enforceable as written by the employers.
The best opportunity for the employee to challenge an overbroad or otherwise unenforceable non-compete agreement will be after the employee has been terminated and a lawsuit is brought to collect damages or to enforce the non-compete agreement. The employee will then have an opportunity to file a motion to enjoin the non-compete as unreasonable and improper in the jurisdiction where the action was filed.
A new tool to challenge and change non-compete agreements in Texas is the "reformation clause" which was approved in 2011. This provision can now be entered as a matter of law by the court to modify a non-compete to make it reasonable, rather than striking the non-compete altogether. This often gives an employer the ability to still enforce a portion of a non-compete that is overbroad while protecting the employee’s ability to continue in a legitimate line of work. More than a few employers have argued that choosing to seek reformation relief is an election by the plaintiff which gives up any right to recover any outstanding damages the defendant might be entitled to.
The employee also has the option of pursuing a declaratory judgment action to establish liability on the part of the employer for enforcing an unreasonable non-compete agreement.
In addition to having the ability to enforce an unreasonable non-compete agreement using the injunction and reformation tools provided by the Texas legislature, the district courts in Texas are also authorized to award damages, attorneys’ fees, and injunctive relief to an employee whose employer has threatened to enforce a non-compete clause in violation of the new law adopted in the last session of the Texas legislature. The courts will also be able to award attorneys’ fees to a prevailing employee in a suit against an overreaching former employer once the law becomes effective.
The only recourse that may be available to employees subject to an enforcing enforcement action for a non-compete agreement that is not based on a threat against the former employee is a Declaratory Judgment action. Declaratory Judgment actions allow the employee to seek an adjudication that the non-compete agreement is unenforceable or unreasonable.
The best alternative, of course, is for an employee in Texas to have the benefit of good legal counsel in determining their rights and obligations with respect to an employer’s attempt to enforce a non-compete agreement.
Future of Non-Competes in Texas
While there have been unsuccessful attempts by the legislature to change the law regarding non-competes, Texans will have to continue living with these contracts for the foreseeable future. In fact, there is a strong likelihood that the trend supporting broad enforcement of post-employment restrictions by Texas courts will continue. It seems that the Texas legislature will not act to modify the current law regarding the enforcement of non-competes in a way that limits enforcement by Texas courts. Additionally , given that most non-competes are drafted by skilled lawyers, the Texas courts will continue to enforce them as long as they meet the relevant legal standards and they are narrowed to the circumstances and industries they are sought to apply to. Texas has a reputation for offering a business-friendly environment, and it appears that it is likely to maintain its friendly attitude towards these agreements. While there may be some changes over the next few years, their future is relatively secure.