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

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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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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Provisions prohibiting the solicitation of customers are treated as covenants not to compete (and thus must meet the requirements applicable to all noncompete agreements). Unlike disclosing the employer's confidential information (which is legally actionable, even without an express agreement by the employee that he will not do so), soliciting the employer's customers constitutes fair competition (unless done via a theft of the employer's trade secrets, a breach of fiduciary duty, etc.), and thus is not actionable unless prohibited by a valid covenant not to compete.  Because the scope of a covenant must be reasonable, a provision prohibiting a salesperson from soliciting any of his former employer's customers might be unreasonable (and might have to be reformed), but a provision restricting the employee from soliciting customers with whom he personally dealt would be relatively more enforceable.

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Practical considerations in this area of the law include the following:
 
For the Former Employer :

1.  In addition to (or in lieu of) a non-compete provision, an employment agreement may contain non-solicitation or employee raiding provisions. A non-solicitation provision typically prohibits a departing employee from soliciting his former employer's customers. The "old" employer should be cognizant of the fact that solicitation
can be very difficult to prove. The departing employee is likely to contend that his new customers contacted him (rather than him soliciting them). Many times, the customers will side with the departing employee. Before filing suit for breach of a non-solicitation agreement, an employer should be confident that it will be able to provide that solicitation occurred.
 
2. Counterclaims are likely. A former employee who is sued for violating a non-compete agreement may file a counterclaim for discrimination, harassment, unpaid wages, or for some other alleged wrong. Before suing a former employee, an employer should try to anticipate possible counterclaims.

3.   One-size-fits-all agreements are not advisable. Every state has its own laws governing non-compete agreements. It is virtually impossible to draft a non-compete agreement that will be enforceable in all 50 states.  Non-compete agreements are particularly difficult to enforce in Texas.  It is important that all employers - and, in particular, non-Texas companies that have employees in
Texas - ensure that their agreements comply with Texas laws.
 
For the Employee:

1. Give everything back. A departing employee should return all of his former employer's property. Taking the former employer's documents or information (including copies thereof) can get the employee sued for conversion, theft of trade secrets, etc. Even in cases where the employee has not signed an agreement requiring her to return company property, she should do so.

2. Beware e-mails. Employees sometimes mistakenly think that e-mails they send from work are "private."  Not so.  By searching computer hard drives and networks, employers can locate e-mails received and sent by former employees, including e-mails that the employee had previously deleted. E-mails sent and received by employees can enable the employer to prove wrongful solicitation of the employer's clients, breach of fiduciary duty, theft, etc.
 
3. Beware phone calls. As with e-mails, employees sometimes erroneously believe that telephone calls they make are undetectable. But telephone records subpoenaed by an employer can yield evidence of wrongful conduct (e.g., solicitation of the employer's customers).  Employees
must be mindful of the fact that telephone calls, like e-mails, are not completely undetectable.

For the "New" Employer:

1. Ensure the new employee is "clean." To the extent possible, the new employer should ensure that its new employee does not possess, use, or disclose to the new employee's other employees any of the former employee's confidential, proprietary or trade secret information.
 
2. The new employer should also get assurance from its new employee that the latter is not a party to a non-compete agreement that prevents the employee from working for the new employee. The new employee obviously needs to protect itself from being sued for tortious interference
with contract, misappropriation of trade secrets, or other wrongful acts.

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An employer may be entitled to injunctive relief to enforce a non-compete agreement in Texas. To obtain permanent injunctive relief, it is not necessary to prove that, without an injunction, the promisee will suffer irreparable harm. But that is not the case with respect to temporary injunctive relief.  Most courts hold that to obtain temporary injunctive relief to enjoin violation of a non-compete provision, one must prove irreparable harm (i.e., that money damages are inadequate).

Irreparable harm may exist if the damages resulting from the breach are hard to quantify, or if the injury cannot be compensated in damages. The threatened disclosure of trade secrets to a competitor can constitute irreparable injury, especially if it would enable a competitor to gain a competitive advantage. Moreover, proof of a continued breach of a non-compete agreement by a highly-trained employee may constitute irreparable harm. In determining whether to grant temporary injunctive relief, the court must balance probable harm to the employer if the injunction is not issued with probable harm to the employee if it is.

In addition to injunctive relief, a court may award damages resulting from breach of a non-compete covenant. Awardable damages might include lost profits resulting from the departing employee's breach of the noncompetition agreement. A non-compete agreement can contain a liquidated damages provision, but the provision must constitute a reasonable forecast of just compensation for the harm caused by the breach.
 
If the court holds that the scope of the non-compete agreement is too broad (e.g., if the court holds that the geographic scope should be limited to Dallas /Fort Worth rather than to all of
Texas), it will reform the scope to make it reasonable. However, if reformation of the scope is required, damages may only be awarded for "post-reformation" violations. For this and other
reasons, an employer has an incentive to ensure that the scope of a non-compete agreement is reasonable.

Attorney's fees and costs may be awarded to the promisor (employee) if he proves that: the scope of the covenant is unreasonable, the employer knew at the time the agreement was signed that it was unreasonable, and the employer has attempted to enforce the covenant to a greater extent than necessary to protect its goodwill or other business interests. Texas cases also hold that an employee who seeks a judicial declaration that a covenant not to compete is unenforceable and void in its entirety may be entitled to recover attorney's fees under the Texas Declaratory Judgment Act.
 
There is no provision in the non-compete statute for an employer who successfully prosecutes an action against an employee to recover attorney's fees.  At least one Texas court of appeals has held that the non-compete statute's silence on this issue precludes an employer from recovering its fees under the statute (or any other applicable law).  However, another Texas court has permitted an employer to recover its fees under the Texas statute allowing the prevailing party in a contract dispute to recoup its attorney's fees.

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