Texas Non-Compete Agreements Lawyer & Attorney : K&L Gates : Trade Secret Litigation : Serving Austin, Dallas, San Antonio

A recent opinion issued by the federal Southern District of Texas sheds a little light on the question of how definite a promise to provide confidential information must be for a noncompete agreement to be enforceable. In Teel v. Hospital Partners of America Inc., No. H-06-3991, 2008 WL 346377 (S.D. Tex. Feb. 6, 2008), the court, quoting the Light case, noted that an "employer's promise to provide an employee with confidential or proprietary information and an employee's reciprocal promise not to disclose such confidential information `would meet the requirement that the covenant be designed to enforce the employee's consideration provided in the agreement.'"

The agreement in Teel stated that the employee's employment "will involve access to and work with" confidential information. The court, without discussion of whether this language was a sufficiently definite promise to provide confidential information, simply confirmed that the employee did in fact receive confidential information and that the restrictions imposed upon the employee were reasonable. 

As noted elsewhere on this blog, several Texas cases discuss how definite the employer's promise to provide confidential information must be for the employee's non-compete promises to be enforceable. Although the Texas Supreme Court in Sheshunoff rejected appellate decisions requiring that confidential information be transferred simultaneously with the signing of a non-compete agreement, it did not explicitly do away with the requirement that the employer actually promise to give the information to the employee.

The question in some cases becomes, "What counts as a promise?" Put another way, "How definite must the promise to provide confidential information be?" In some cases, the employee’s “acknowledgment” that he will receive confidential information gets characterized as an "implied" promise by the employer to convey the information. In the Teel case, the statement that the employee's work "will involve access to and work with" confidential information was evidently deemed to be a promise--either explicit or implied--that the employer would provide such information to the employee.

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In a recent Texas case involving a restrictive covenant, the plaintiff contended that the duration of the non-compete covenant should be judicially extended beyond the agreement’s normal expiration date. In that case, the seller of a dance studio entered into an agreement in which she promised not to compete with the buyer. As is true in most states, non-compete covenants contained in buy-sell agreements are more enforceable than those contained in employment agreements. The covenant in this case was for five years, and the geographical scope consisted of a 50-mile radius around Waco.

The buyer subsequently sued the seller, contending that the latter was in breach of the non-compete agreement. The trial court granted the plaintiff’s motion for summary judgment and an appeal was taken.

On appeal, the seller contended that the trial court erred in holding that the ending date of the covenant not to compete was five years from the date of judgment (as opposed to five years from when the non-compete agreement was signed). The buyer responded that the trial court was right to “equitably extend” the duration of the covenant because of the seller’s “continuous and persistent” violations of the covenant.

The evidence for the alleged “continuous and persistent” violation was as follows:

The Sale and Purchase Agreement was signed on February 27, 2004. Lezley did not begin working for Unity Dance and the Bratchers until July 11, 2005. On August 31, 2005, the trial court temporarily enjoined Lezley from either directly or indirectly soliciting or encouraging any current and/or potential students of Holley's dance studio, Jenni Holley Dance Designs, to become either her student or the student of any other dance company or teacher within 50 miles of Holley's dance studio. She was not specifically enjoined from teaching dance. Unity Dance and Bill and Donna Bratcher were enjoined from either directly or indirectly using Lezley's name in their advertising. They were also enjoined from soliciting or encouraging by direct contact any persons known by them to be current customers of Holley's dance studio as long as Lezley was working at Unity Dance. There is no indication in the record that Lezley, Unity Dance, or the Bratchers violated this temporary injunction.

Based upon these facts, the court of appeals held that the trial court erred in equitably extending the non-compete covenant.  However, the court also stated, “We do not hold that a covenant not to compete cannot be equitably extended, but hold that the record does not support Holley’s argument that the violations of the covenant, if any, were `continuous and persistent.’” 

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What happens if an employer seeking to enforce a non-compete agreement is itself in breach of the agreement.  Does the employer's previous breach adversely affect its ability to enforce the non-compete?  Maybe.

It's "hornbook" law in Texas that one party to a contract is precluded from enforcing a contract if that party itself is in “material” breach. In DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 682 (Tex. 1990, the Texas Supreme Court explicitly recognized that an employer in material breach of an employment agreement could be estopped from enforcing the non-compete provisions contained therein.  Of course, an issue in every case will be whether, assuming the employer is in breach, the breach is “material.”  Failure to pay compensation to which the employee is entitled might, in appropriate circumstances, qualify as material.  Thus, an employer wishing to enforce a non-compete agreement should ensure that it is not already in material breach.

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In our practice we see many disputes between doctors and their employers from both sides of the fence. Quite often these disputes are between practices or institutions and doctors who are just “hitting their stride,” developing loyal patients and looking at their practice options for the future. At that point, both parties search for the contract they signed and put in a drawer a few years earlier and begin examining its arcane phrases with a scanning electron microscope.

The eventual terms of any agreement between a doctor and his or her employer depend on many factors, including the respective bargaining power of the parties. We thought it would be helpful for you to have a road map of the terms you are likely to encounter in your first agreement.

Like any document prepared by a lawyer, there is some fine print at the end. In the meantime, give some thought to these items (which by no means exhaust the important provisions of an employment agreement) before you make your first commitment as an employee:

How Long.   What is the duration – called the “term” –  of the contract? This is the duration of your employer’s commitment to you, and yours to your employer.   Is it long enough to allow you to establish your practice? Is it so long that you would be unfairly stuck with a fixed compensation structure while your practice grew?   Does the contract automatically renew at the end of the initial term and keep renewing (usually for a year at a time) unless one side cancels with notice (called an “evergreen clause”) – which can be both good or bad, depending on how the contract handles it?

How Much.   How is your compensation set? Is it tied to performance?   If so, does the contract fairly allow you some influence on your performance goals and your employer’s support in meeting them?   This tends to be a business term heavily influenced by market factors, but you still need to ensure that your future employer gives you a fair shot to maximize your income. 

Review incentive compensation and bonuses. When are they paid? What offsets will the practice take for expenses (such as technicians and nursing staff). If you leave before you receive a bonus, are you entitled to a pro rata share of the bonus or incentive compensation?

Out-of-Pocket (or Purse).    You will have a lot of expenses.   Most employers pay or reimburse the basics, but consider some unusual expenses, such as costs associated with providing services at multiple locations, and don’t forget necessary certifications and continuing medical education. Don’t assume that your employer will pay all expenses of you being a doctor – get it clear up front.

Vacation.   Is there a paid vacation policy? What if you can't or don't choose to take all your paid vacation? Will the days roll over to the next year, or can you cash out your unused days?

Sick Leave/Personal Time.    What does your employer provide if you are temporarily disabled due to injury or illness?  Does the agreement define the term "disability”? If you are disabled, how long will you receive your base compensation?  If you have minimum collection requirements in your contract, can this be adjusted to take into consideration a decrease in productivity due to a temporary disability?

On Call Obligations.   Are your “on call” coverage obligations clearly spelled out? Is call limited to specified locations?

If Your Contract Doesn't’t Go to Term.   Yes, it happens. That great relationship at the outset of your employment can sour for a multitude of unforeseeable reasons. What are the conditions permitting either you or your employer to terminate the agreement before the end of its term?  The procedures are critical here. This is a major source of litigation, as is: 

Noncompetition Agreements. The hands-down winner in the I-guess-I-need-to-call-a-lawyer sweepstakes is the famous “covenant not to compete” provision, sometimes shortened to “noncompete.” This is a provision that limits (but does not entirely prohibit) an employee’s ability to work elsewhere after the employment ends or is terminated.   Some doctors are under the misimpression that these provisions are not enforceable in Texas because they are anticompetitive. Not – we repeat, not – true. It is true that there are special conditions imposed upon them in Texas, but if those conditions are met, courts will enforce contract provisions that keep you from practicing within a certain geographical area for a certain period of time after your employment ends. The good news is that there are ways to limit the effect of such provisions. 

Partnership.    If your employer is a medical practice, consider requiring a commitment on its part to consider you for partnership (or whatever form of ownership the practice uses) after a certain period of time.

Your Patients’ Records.   Your contract may end or your contract may be terminated prematurely. Either way, if you have your own patients you are going to want their records.   You need to provide for that in the agreement.

The More Things Change.   With federal law and regulation changing rapidly with respect to matters such as recordkeeping, reimbursement, and even compensation itself, employers have begun inserting provisions permitting them to make unilateral changes to the contract to keep it in compliance with law. Sounds reasonable, but you should have notice of the change and the opportunity for input (or the option to bail out).

Malpractice Insurance. Yes, your employer will provide it, but it’s more complicated than that – what happens when your employment is over? This issue is of particular importance with respect to your second employer and something called tail insurance.  Big-dollar item.

Dispute Resolution. If you have a dispute over the terms of the employment agreement, how will it be resolved?   Frequently (and, in the case of hospitals, almost always) employment agreements provide for mandatory arbitration (that is, the parties cannot go to court; the dispute is heard by a non-judge with no jury).   Does the contract provide that both sides must conduct a face-to-face meeting before initiating legal proceedings?  Is there a provision requiring the loser to pay legal fees, and, if so, which side does it favor? (One guess.)

Two Sides to Every Story. We have focused here on things that the new doctor is going to want. Your employer is going to want some things, too, and it’s going to insist on them:   Getting and keeping your license; maintaining your privileges at hospitals; abiding by the rules and regulations of the practice or institution; complying with legal requirements; and many more. Still, you want to make sure your employer doesn’t slip in anything unreasonable, or phrases it in such a way that it turns out to be at “gotcha” at some later date.

As noted, this list only hits the highlights. There are many other possible provisions the new employee should carefully heed.

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Texas courts routinely hold that at-will employment is "illusory" consideration.  Because the employer is free to terminate the employee at any time, the courts reason, giving an at-will job to someone is, legally speaking, meaningless.  Thus, non-compete agreements in Texas based upon that consideration are unenforceable.

Not all states agree.  While researching a noncompete matter in Illinois the other day, I came across this passage from a case there:

To be enforceable, a covenant not to compete must be ancillary to either a transaction (an otherwise valid contract), or a valid relationship.  Although an at-will employment agreement, whether written or oral, might not be considered "enforceable" in the strictest sense of the term, it is nonetheless an agreement and relationship with numerous legal consequences, imposing rights and obligation son both parties.  Therefore, a noncompetition covenant entered into by an at-will employee, whether the employee is employed under a written or oral agreement, complies with the requirement of ancillarity.  This is because a covenant in such a situation is not a "naked" restraint on trade, but instead is merely ancillary to the primary purpose of the relationship: an employer-employee relationship.  Thus, noncompetition covenants occurring in at at-will employment relationship are not enforceable per se.

According to this court, hiring an at-will employee subjects an employer to potential legal risk.  For example, the employee, even though she is at-will, is entitled to all protections under Title VII, the ADA, the ADEA, workers' compensation laws, the FMLA, and other laws.   The Illinois court held that at-will employment, therefore, is good consideration, not "illusory" consideration.  Although Texas courts disagree, it's interesting to examine foreign law holding otherwise.

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Texas courts have long held that Texas law should determine whether non-compete agreements affecting Texas residents are enforceable.  As a result, Texas courts generally will not enforce out-of-state choice of law provisions.  However, as a recent Texas Supreme Court case illustrates, contractual forum selection provisions can alter that result.

In Re AutoNation, Inc. involved a suit filed in Broward County, Florida, by a Florida corporation (AutoNation) against one of its former employees for allegedly violating a non-compete agreement.  A forum selection provision in the agreement mandated that suit be filed there. 

Shortly thereafter, the former employee--who lived and had worked for AutoNation in Texas--filed suit in Texas state court, seeking a declaration that the non-compete agreement was unenforceable under Texas law, and seeking to prevent the Florida suit from going forward.  The ex-employee, citing some Florida case law, contended that a Florida court likely would apply Florida law to the contract.  Given Texas’ strong public policy favoring the application of Texas law to the contract, the ex-employee argued, a Florida court should not be permitted to adjudicate the dispute. The Texas trial court agreed and enjoined AutoNation from taking further legal action against the ex-employee outside of Texas.  The trial court held, "Texas public policy will likely be thwarted if AutoNation is permitted to litigate enforceability of the restrictive covenants solely in Florida and solely under Florida law."  The court of appeals affirmed.

The Texas Supreme Court reversed.  In doing so, the court held that forum selection clauses--unless procured through fraud or overreaching--are enforceable.  The court also acknowledged Florida's interest in the dispute (given that AutoNation's headquarters were located there).  The court then refused "to presume to tell the forty-nine other states that they cannot hear a non-compete case involving a Texas resident-employee and decide what law applies, particularly where the parties voluntarily agree to litigate enforceability disputes there and not here."

In a concurring opinion, Justice O'Neill wrote:

What is not apparent . . . is that enforcement of the forum-selection clause in this case will result in application of the contractual forum's law in a manner that will undermine Texas public policy. Had there been a clear showing to this effect, I might agree with the court of appeals' analysis, or at least would consider the trial court justified had it decided to abate the Texas declaratory judgment action pending the Florida court's decision. But a mere indication that the Florida court intends to apply Florida law does not, without more, justify a Texas court's interference with the parties' chosen forum.

Time will tell whether Justice O'Neill's concurrence takes some of the bite out of this decision.  Based upon her concurrence, the next Texas resident who's sued in a foreign jurisdiction for allegedly violating a non-compete agreement may contend: (a) the foreign jurisdiction is likely to apply its law and (b) that law is contrary to Texas public policy.  The latter point might be made, for example, if the foreign state’s law is that at-will employment is sufficient consideration for a non-compete agreement (as opposed to Texas law, which states that such consideration is “illusory”).  Whether a stronger showing on the public policy issue than was made in this case could change the result is unknown.

In the meantime, given Texas’ relative hostility to non-compete agreements, out-of-state companies who have employees here should consider adding non-Texas forum selection provisions to their non-compete agreements.  Based upon this decision, they may be enforceable.

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Non-compete agreements routinely provide for the employer to get injunctive relief in the event the employee engages in post-employment competition. In a recent case, the agreement in question subjected the employee to potentially harsher penalties. 

The non-compete in question contained the following provisions:

14.     Restrictive Covenant. In consideration of the benefits being provided to the Employee pursuant to this Agreement as outlined in Section 12 and elsewhere, and the unique nature of the Firm's Clients and their business with the Firm as outlined in Section 12, the Employee shall neither call nor solicit, either for himself or for any other Person any of the clients of the firm for a period of twenty-four (24) months immediately following the Employee's period of active employment (the "Post Termination Period")….

15.     Payments to firm. …[T]he Firm and the Employee agree that should any Client of the Firm retain the services of Employee or any Person with whom Employee is associated at any time during the "post Termination Period", regardless of whether or not solicited by the Employee or such Person, the Employee shall pay to the firm an amount equal to 150% of the fees billed and accepted by such client during the twelve month period preceding the time when the client retains the services of the Employee or any Person with whom Employee is associated….

The court refused to uphold these provisions on the following grounds:

First, the court held that the monetary penalty was unreasonable. The court explained it in this way:  “[I]f Hardy prepared a $500 tax return for a client, and if the same client paid $50,000 during the previous year for accounting services provided by Mann Frankfort, Hardy would have to pay $75,000 to Mann Frankfort."

The court believed this to be excessive.

Second, the court objected to the “Restrictive Covenant” provision:

Hardy's restrictive covenant is not limited to the clients that he served. The agreement states that he may not call or solicit "any of the Clients of the Firm" for 24 months. The client-purchase provision similarly refers to "any Client of the Firm."  This type of restrictive covenant that does not require a connection between the clients and the person who is restricted by the covenant is overbroad. 

The court continued:

The agreement contains no geographical restrictions, no restrictions to clients that were actually served by Hardy while he was employed by Mann Frankfort, and an exorbitant fee for Hardy's service to clients that did business with Mann Frankfort.  We hold the restrictive covenant is unenforceable due to its failure to comply with the requirements of the Texas Business Code.  Because Hardy's agreement fails to comply with the Covenants Not to Compete Act, it is unenforceable, as written. (citation omitted)

In all cases involving non-compete agreements, the non-compete restrictions must be reasonable to be enforceable. In this case, the court held that the restrictions were unreasonable.

Hardy v. Mann Frankfort Stein & Lipp Advisors, Inc., 2007 WL 1299661 (Tex. App.—Houston [1^st Dist.] May 3, 2007).

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Here's an interesting article about a proposed bill in Tennessee to make physician non-compete agreements enforceable.  The proposed bill is in reaction to a Tennessee Supreme Court ruling that noncompete agreements are void unless specifically allowed by the state legislature:

http://phoenix.bizjournals.com/memphis/stories/2007/06/04/daily32.html

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In a recent case in Houston, the First District Court of Appeals upheld a trial court’s failure to reform an overly broad covenant not to compete. The covenant was overly broad in three respects: (a) there was no geographical limitation; (b) the covenant prohibited the employee from contacting all of his former employer’s customers, not merely the customers with whom the employee personally dealt; and (c) the employee was required to pay a harsh financial penalty if any customer continued doing business with him (whether or not the employee solicited the customer).

Tex. Bus. & Com. Code § 15.51(c) states in part:

[T]he court shall reform the covenant to the extent necessary to cause the limitations contained in the covenant as to time, geographical area, and scope of activity to be restrained to be reasonable and to impose a restraint that is not greater than necessary to protect the goodwill or other business interest of the promise and enforce the covenant as reformed, except that the court may not award the promise damages for a breach of the covenant before its reformation and the relief granted to the promise shall be limited to injunctive relief. (emphasis supplied)

Despite this provision’s seemingly mandatory requirement that an overly broad covenant be modified, the trial court failed to do so, for two reasons. First, the employer did not plead for reformation. Second, the employer only sought damages. The latter point was significant, the court believed, “because the only relief available under a reformed covenant—injunctive relief—was not sought by [the employer].” 

Practice pointer: In cases in which you believe the covenant may be too broad (which may be true in some respect in most cases), plead for reformation. Also, seek injunctive relief, even if you don’t think you’re entitled to a temporary restraining order, to increase the likelihood that the court will view reformation as something that is warranted.

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Interesting piece on increasing pervasiveness of non-compete agreements throughout the United States:

http://minnesota.publicradio.org/display/web/2007/04/24/noncompete/

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As we noted last week, how strongly an employer must promise to provide confidential information to have an enforceable non-compete agreement remains unclear, even after Sheshunoff.  Interestingly, though, there appears to be some divergence on the issue between the Dallas and Houston courts of appeal.  And the Austin court seems to be sympathetic to the Dallas court’s position.

Before Sheshunoff, the Dallas court, in three cases (C.S.C.S., Strickland, and Tom James), appeared skeptical that language such as “may reveal,” “Employee will become familiar with,” and “this Agreement is intended to recognize that Employer provides Employee with confidential information,” obligated the employer to provide such information.  However, in two of the cases, the fact that the alleged promises depended upon continued at-will employment were key factors in the decisions.  And the third case—C.S.C.S.—involved the weakest language (“may reveal”). 

However, the Houston court—or, at least, the First District of that court—held that an employee’s acknowledgement that she would get confidential information constituted an implied promise by the employer to give the information.

In the context of one company purchasing another company, a non-compete agreement is far more enforceable than it would be in an employer/employee situation.  That's hornbook law.  A good explanation for this was given in a Texas Supreme Court case:

In the case of covenants not to compete incident to the sale of a business, the seller's promise not to compete with the buyer increases the value of the business to the buyer.  Without such a covenant the value of the business would be reduced, lessening the likelihood that businesses would be purchased.  In employee covenants, the special training or knowledge acquired by the employee through his employer is valuable consideration and often enhances the value of the employee to other firms.  To allow employees to use or sell this valuable training or knowledge upon leaving a firm would create a disincentive for employers to train or educate employees.

Thus, in buy/sell situations, covenants not to compete are understandably easier to enforce, and their scope can be much broader than employer/employee covenants can be.

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In several states, an employer may--via a non-compete agreement--prevent a departing employee from taking advantage of the relationships the employee developed with the former employer's customers.  This is true whether or not the identities of the former employer's customers are "confidential."

In those states, therefore, the former employer can successfully contend, "We introduced you to our customers and you've developed good relationships with them, but you can't compete with us by taking advantage of those relationships."

There are actually a couple of Texas Supreme Court cases that stand for the proposition that protecting customer relationships is an interest sufficient to justify a non-compete agreement.  However, those cases have been largely ignored in recent years.

In Peat Marwick Main & Co. v. Haass, 818 S.W.2d 381, 387 (Tex. 1991), the court noted:

The fundamental legitimate business interest that may be protected by such covenants is in preventing employees or departing partners from using the business contacts and rapport established during the relationship of representing the accounting firm to take the firm's customers with him.

In an earlier case, Henshaw v. Kroenecke, 656 S.W.2d 416, 418 (Tex. 1983), the court had stated:

Henshaw had a right to protect himself from the possibility that Kroenecke would establish a rapport with the clients of the business and upon termination take a segment of that clientele with him.

Today, whenever an employee leaves and begins "stealing" his former employer's customers, courts focus on whether the identities of those customers are "confidential."  Usually, they are not.

To determine whether customer identities are confidential, courts ask questions such as, "Can the information be easily located (e.g., in telephone books or trade journals)?, and "Did the employer take reasonable steps to keep the information confidential?"  These standards are difficult to meet.

But in several other states, the employer need not prove that the information is confidential.  Rather, protection of the employer's relationship with its customer--whether or not the customer's identity is secret--is sufficient to support a non-compete agreement.  A few Texas cases used to speak in those terms as well.

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Even after Sheshunoff clarified the law governing non-compete agreements, we continue to see agreements that cause us to scratch our heads and wonder whether they are enforceable. Sheshunoff made clear that, even in an at-will employment situation, a delay between the employee signing the non-compete agreement and receiving the information is not fatal to the agreement’s enforceability.

However, “How strong must the promise be?” is a question that remains somewhat unanswered. Prior to Sheshunoff, several appellate court decisions considered agreements in which (a) the employee “acknowledged” that he would receive confidential information; (b) the employer expressed its “intent” to provide such information; (c) the employer promised to provide information to the employee that the employee “needed” to do the job, and so on.

In those cases, the employee routinely contended that the employer really didn’t promise anything (because the employer could decide not to provide information). Thus, the employee argued, the employer couldn’t rely upon an alleged promise to provide confidential information to justify the employee’s promise not to compete.

Unfortunately, many, if not most, of the pre-Sheshunoff appellate cases that dealt with these issues invalidated the non-compete agreements in question because the alleged employer promises were “illusory”—because they depended upon continued at-will employment.  Before Sheshunoff, a promise dependent upon continued at-will employment was meaningless.  After Sheshunoff, such a promise is enforceable.

Again, though, what is a “promise”?  Must the word “promise” appear in the agreement? Probably not. Terms such as “shall provide” or “agrees to provide” should suffice. But whether a simple “acknowledgement” by the employee that he will receive confidential information is enough is unclear. Some of the pre-Sheshunoff cases opined that terms like these might constituted “implied” promises on the part of the employer to provide information, but a lot of that language was dicta (because the cases were decided on the issue noted above). Now that Sheshunoff has held that the conveying of information need not occur at the moment of signing the agreement, we can expect to get some appellate decisions that squarely define how strong the employer’s promise must be.

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I often hear from employees who are bound by non-compete agreements that "Texas is a right to work state," and that, therefore, their agreements are unenforceable.

Not true.  The "right to work" concept has NOTHING to do with non-compete agreements.

Rather, the "right to work" concept has to do with the right of employees to decide for themselves whether they will financially support a union (assuming there is one).  It has nothing to do with whether non-compete agreements are enforceable.  Nothing whatsoever.

So, if you are bound by a non-compete agreement and someone says, "That's unenforceable--Texas is a right to work state," ignore them. 

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Company X's employee (who is bound by a non-compete agreement) resigns and begins working for Company Y (a competitor of Company X).  Company X sues its former employee for violating his non-compete.  Months later, they reach a settlement, and a final judgment is entered.

Company X can then sue Company Y for tortiously interfering with the non-compete agreement between Company X and its former employee, right?  Maybe not.

In KForce, Inc. v. Surrex Solutions Corp., 436 F.3d 981 (8th Cir. 2006), the federal Eighth Circuit Court of Appeals, applying Missouri law, held that filing a second suit (against the new employer) would result in the plaintiff being compensated twice for the same injury.  Thus, the second suit was barred.

Time will tell whether Texas courts adopt the holding in KForce.  However, just as in Missouri, it is the law in Texas that an injured party cannot be compensated twice for the same injury.  Thus, it's possible that the KForce rationale would apply here.

Lesson:  Be careful about settling with your former employee before you add his new employer as a defendant (unless you have no intention of ever doing so).  If you settle with the former employee, you may not be able to pursue the new employer.  The safest course, if you are inclined to seek relief (including injunctive relief) from both parties, is to name the ex-employee and his new employer as defendants from the outset.

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What happens when an employer gives an employee stock in exchange for a non-compete agreement, but the non-compete agreement is held to be unenforceable.  Does the employee still get to keep the stock?  This question was raised in a case in which the employer gave a ten percent ownership interest in the company to one of its employees. The employer prepared a stock certificate in the employee’s name, but it retained possession of the stock certificate. 

Approximately four years after executing the agreement, the employee left the employer and took a job with a competing company. The employer claimed that because the employee breached the non-compete agreement, he was not entitled to the stock. The employee filed suit seeking a declaratory judgment that the stock issued in his name should be delivered to him.

The trial court ruled that the noncompete agreement amounted to an unenforceable restraint of trade and awarded the employee the stock. The court of appeals agreed that the noncompete agreement was unenforceable, because it was unlimited as to time and extended to customers with whom the employee had no association with while working for the employer. 

However, the court also held that the employee should not receive the stock. In reaching this conclusion, the court considered whether the promise not to compete and the promise of stock were mutually dependent promises. That is, but for the employee’s promise not to compete, the employer would not have promised to give him stock.  Because the employer did not get what it bargained for (i.e., the employee’s noncompetition), the employee was not entitled to the consideration promised by the employer (i.e., the stock). Therefore, the employee was allowed to work for the new employer, but he lost the stock. 

As we can see from this case, an employee who challenges the enforceability of a non-compete agreement may, if he or she prevails, forfeit the consideration (in this case, stock) that was given for the non-compete.

John R. Ray & Sons, Inc. v. Stroman, 923 S.W.2d 80 (Tex. App.—Houston [14^th Dist.] 1996, writ denied).

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Another quick hit on the ramifications of Sheshenoff.  In recent years, employers have not infrequently added to their non-compete agreements a promise to convey confidential information to the employee, even if the employee no longer worked for the employer when the information was conveyed.  The purpose of this was to address the employee's argument that, "Because I'm an at-will employee, the employer's promise to provide me with confidential information is illusory because I could be fired before I get it."  Employers dealt with this by contending, "We promised to give him the information regardless of whether he was still employed--thus, our promise was not illusory."

One of the good things about Sheshunoff is that it makes game-playing like this no longer necessary.  Employers need not promise to give confidential information to departed employees.  Employers only need to promise to give the information and then do it (the sooner, the better).

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It's commonly believed--and rightly so--that the Texas Supreme Court's recent decision in the Sheshunoff case makes non-compete agreements relatively more enforceable.  However, let's keep in mind a couple of things that didn't change [even if these are obvious points].

Number one, even after Sheshunoff, if the consideration given for the non-compete agreement is confidential information, the employer must still promise to give it.  Sheshunoff rejects the notion that the confidential information must be provided at the moment the agreement is signed.  However, in that case, the employer did promise to convey the information.  Conversely, if the agreement in that case merely had the employee "acknowledge" that he might receive the information, the non-compete agreement likely would not have been enforced.  Thus, this element of Texas non-compete law has not changed.

On a related note, the confidential information must actually be confidential.  That's an obvious point, perhaps, but the bigger point is this:  the holding in Sheshunoff was not, "Non-compete agreements are now enforceable in Texas."  It was a lot more nuanced than that, and there are still many other requirements that must be met.

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In its October 20, 2006 ruling in Alex Sheshunoff Management Services, L.P. v. Johnson, the Texas Supreme Court injected a bit of sanity into the complex debate over covenants not to compete in the at will employment context.  Modifying earlier decisions, including Light v. Centel Cellular, the Court held that a covenant not to compete can become enforceable when an employer provides confidential information or specialized training to an employee, even if that occurs at some point after the employee signs the agreement.  Based on the earlier cases, an employer had to either (1) unconditionally agree to give the employee confidential information or training even if the employee was at will and terminated prior to receiving the training or information; or (2) provide confidential information or specialized training to the employee at the very instant the covenant not to compete was signed.  The earlier decisions rationalized that a promise to provide in the future confidential information or training in an at will relationship was illusory, since the employer could avoid the obligation by firing the employee at any time.  Indeed, one Texas Court of Appeals invalidated an covenant not to compete based solely a delay of only four hours between the signing of the covenant and the delivery of confidential information to an at will employee .

In Sheshunoff, the Supreme Court ruled that in an at will employment relationship, a covenant not to compete based upon a promise to provide future confidential information during employment would become enforceable when the employer actually performs the unilateral offer and provides the confidential information to the employee.  This rationale reflects the practical realities of the employment relationship, and makes the creation of enforceable covenants more practical for employers.  However, employers should keep in mind that any covenant not to compete must be ancillary to the employee's promise to maintain the information as confidential, and the covenant must be designed to enforce the employee's consideration or promise not to disclose or use the information.  Of course, the Texas statutory requirement that the covenant's restrictions must be reasonable in terms of geographic scope, time limitations and scope of activity continues to apply. Nevertheless, the Sheshunoff decision provides greater guidance and comfort to employers seeking to craft and enforce reasonable non-competition agreements as part of an overall agreement to preserve the employer's confidential information.

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Many management attorneys are breathing a huge sigh of relief today.  In a much-anticipated decision (oral argument was almost two years ago), the Texas Supreme Court clarified what it takes to make a non-compete covenant enforceable.  In doing so, the court resurrected many agreements that were previously thought to be unenforceable.

For years, Texas courts have held that, with respect to non-compete agreements, a promise dependent upon continued at-will employment is no promise at all.  Such a promise was "illusory," the courts held.  Thus, a promise to give an at-will employee a raise, a promotion, stock options, or confidential information was "illusory," unless whatever was promised was delivered at the precise moment that the employee signed the agreement (otherwise, the employer could terminate the employee before fulfilling its promise).

Perhaps the most severe application of this rule occurred in the Trilogy case, decided by the Austin Court of Appeals in 2004. There, an at-will employee signed a non-compete agreement at 10:00 a.m.  Four hours later, the employer said, "Here’s the confidential information that we promised to give you in the agreement you signed this morning."  When the employer subsequently tried to enforce the non-compete agreement, the court held that the four-hour gap between the employee’s signing the non-compete and his receipt of the confidential information rendered the non-compete unenforceable (because the employee could have been fired in the interim, even though he wasn’t). The fact that he could have been fired meant that the employer’s promise to convey the confidential information (made at 10:00 a.m.) was dependent upon the [at-will] employee still being employed when he finally received the information.  Because there was no guarantee that the employee would still be employed at 2:00 p.m., the employer’s promise made at 10:00 a.m. was "illusory."   

That decision, even though a logical extension of the law as it existed at the time, is no longer the law in Texas.  In a case decided a few days ago, the court held that even in the case of an at-will employee, a gap between the employee’s signing the agreement and his receipt of the confidential information will not render the agreement unenforceable.  The moment the employee gets the confidential information--whether it occurs four hours, four weeks, or four months after he signs the agreement--the non-compete agreement becomes effective.  

The court has clarified the law, in a much needed way.  Non-compete agreements are now relatively more enforceable.  And I have lost one of the few lines in my typical non-compete speech that ever got a laugh (or at least a grin)--when I demonstrated how an employer should have an employee sign the non-compete agreement with his right hand, while accepting the confidential information with his left.  That’s no longer necessary.  A delay between the employee signing the agreement and getting the information is no longer fatal.

There’s a lot more to the case, and we will be discussing it in depth in the days and weeks ahead. But it’s time to find the non-compete agreements that we thought were dead and see if this decision has resurrected them.

Alex Sheshunoff Mgmt. Servs., L.P. v. Johnson, et al., No. 03-1050 (Tex. Oct. 20, 2006).

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One of the most frequently-litigated issues involving noncompete agreements is whether the consideration given by the employer was adequate. There are generally two parts to the inquiry: one, whether the consideration given was real (i.e., not “illusory”); and two, whether the consideration given justified the noncompete agreement in question.

Giving a definite term of employment satisfies the first requirement, but it might not satisfy the second (because the court may not perceive a logical relationship between the term of employment given to the employee and the need to keep that employee from engaging in post-employment competition). Conversely, the giving of confidential information can satisfy the second prong, but if the promise to convey the information is not sufficiently definite, it may be held to be illusory.

In a case earlier this year, the consideration for the non-compete agreement consisted of:

        a.    a six-month term of employment;

        b.    employment beyond the initial six-month period for as long as the employer was satisfied with the employee’s work; and

        c.    a promise to convey confidential information.

Sometime later, the employee resigned, began working for a competitor, and was sued on his non-compete agreement. The employee contended that the non-compete was unenforceable. However, the trial and appellate courts disagreed, the latter holding that the employer “was obligated to fulfill its promises [to provide confidential information and specialized training] for at least six months.”  This promise to provide confidential information was held sufficient to make the covenant not to compete enforceable.

Thoughts:

1.  Courts have routinely held that a promise to provide confidential information in an at-will employment situation is not enforceable because there is no guarantee that the employee will get the information before she is fired (i.e., the employer might not get around to providing the information until days, weeks, or months after the agreement is signed).   Of course, if the employer promises to give the information when the agreement is signed, and does so, it might be enforceable.

2.  The facts of this case make the following argument by the employee possible:  "There was no guarantee that I would get the confidential information within the first six months of employment. Thus, my situation is not substantively different from an at-will employee who has no guarantee that he'll ever get the information he was promised." In this case, though, the court treated the above promises, collectively, as a guarantee that the employee would receive confidential information during the first six months of his employment (thereby making it a non-illusory promise).

3.  Belt and suspenders approach is best:  Combining a term of employment with a promise to provide confidential information at the instant the agreement is signed (and then doing it) is a good way to increase the likelihood that the non-competition agreement will be enforced.

4.  This is not to suggest that a term of employment per se makes a non-compete agreement enforceable.  The point of this case is, the court believed that a six-month term of employment meant that the employer's guarantee to provide confidential information (which gave the employer an interest in preventing competition) was not "illusory" (although the promise to provide confidential information might have been illusory in an at-will employment situation).

Pearson v. Visual Innovations Co., Inc., No. 03-04-00563-CV, 2006 WL 903736 (Apr. 6, 2006, no pet.).

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In a recent case, the employer's consideration in exchange for the employee's promise not to compete was set forth in the following provision:

Employer hereby agrees to provide to Employee any specialized training necessary, in the opinion of Employer, to allow Employee to conduct the duties of employment with Employer. Employer further agrees to provide to Employee any of Employer's proprietary and confidential information necessary to allow Employee to conduct the duties of employment with Employer.

The employee contended that this provision didn't obligate the employer to do anything, because the employer might have concluded that no specialized training (confidential information) was needed for the employee to do her job. The court [of appeals] disagreed:

[T]he trial court could have concluded that Rattikin was in fact bound to provide O'Brien with confidential and proprietary information and specialized training. The agreement merely gives Rattikin the option of determining, in its opinion, what confidential and proprietary information and training it should provide O'Brien during the course of her employment.

Observations:

1. The best practice for an employer is to unambiguously promise to provide confidential information at the moment the non-compete agreement is signed, and then do it.

2. This case illustrates the difficulty in predicting with certainty whether a particular non-compete agreement is enforceable. Clearly, the employee in this case had a plausible argument that the employer maintained sole discretion over whether to provide specialized training or confidential information, and that, therefore, the alleged consideration was "illusory." The court disagreed with this interpretation, but the employee (and her attorney) no doubt believed in the correctness of her legal position.

O'Brien v. Rattikin Title Co., No. 2-05-238-CV, 2006 WL 417237 (Tex. App.--Fort Worth Feb. 23, 2006, pet. filed).

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