Mysteries of Texas Non-Compete Law, Part 1

Nineteen eighty nine, the number . . .

A big anniversary is coming at the end of the summer. Yes, August 1 will be the 38th anniversary of the debut broadcast of MTV, which kicked off with “Video Killed the Radio Star.”

But I’m talking about a different anniversary: the 30th anniversary of the Texas non-compete statute, which became effective just a few weeks later on August 28, 1989.

That was a long time ago. The #1 song that week was “Right Here Waiting” by Richard Marx. I was probably sweating through summer marching band practice at Crockett High School in south Austin, Texas. With no cell phone, no email, and no social media.

It was not long before the statute was amended—in 1993—but otherwise the statute has remained the same for 30 years.

Since that time, the Texas non-compete statute has traveled a long and winding road through the Texas courts. I won’t bore you with the details, but in those 30 years there have been hundreds of Texas appellate opinions applying the statute, including at least a dozen opinions from the Texas Supreme Court. Plus opinions by federal courts applying the Texas statute.

With so many judges writing so many opinions, you would think that any big questions about application of the Texas non-compete statute would be answered by now.

But you would be wrong.

It is surprising how many fundamental questions about Texas non-compete law remain unanswered today. I talked about some of these at a presentation a few years ago called “Advanced Non-Competes: What You Don’t Know You Don’t Know Can Hurt You.”

To celebrate the upcoming 30th anniversary, I’m revisiting that topic. It will be like an MTV countdown, but with non-competes, and less spandex. I’ll pick the most important unanswered questions of Texas non-compete law, explain each one, and look at how some recent court decisions have tried to answer them.

To kick this off, I’m starting with perhaps the most basic unanswered question: to enforce a non-compete against a departing employee, does the employer have to prove that the information it provided to the employee was actually confidential?

And the subsidiary question: how “confidential” or valuable does that confidential information need to be?

But first, let’s back up a bit to put these questions in context. The Texas non-compete statute has two requirements. First, the non-compete has to be “ancillary to an otherwise enforceable agreement.” Second, the non-compete has to be reasonable.

For now, let’s put aside the whole “reasonableness” question and focus on the “ancillary” requirement. What does it mean for a non-compete to be ancillary to an otherwise enforceable agreement?

The Texas Supreme Court has told us one way this “ancillary” requirement can be satisfied: an employer can tie a non-compete to a confidentiality agreement with an employee.

An agreement to provide the employee specialized training can also satisfy this requirement. That’s why my form, the Plain-Language Non-Compete, contains both an agreement to provide confidential information and an agreement to provide specialized training.

But a confidentiality agreement is still the most common way Texas employers try to satisfy the ancillary requirement. There are thousands of Texas non-competes written this way. The employer agrees to provide the employee with confidential information in connection with the employee’s work, and the employee agrees to a non-compete.

Is it enough for the employer to say these magic words? If the agreement says the employee will receive confidential information, is the non-compete enforceable? And what if the employment is at-will, as in 99% of cases? Is there really an “otherwise enforceable agreement” if the employer can fire the employee five minutes after she signs the agreement? Would the employee still be bound by the non-compete?

Texas courts struggled with questions like this for over two decades, but the Texas Supreme Court finally decided to make things simpler in a case called Alex Sheshunoff Management Services, L.P. v. Johnson, 209 S.W.3d 644 (Tex. 2006).

The Sheshunoff court solved the problem this way: a non-compete is ancillary to an otherwise enforceable agreement if the employer agrees to provide the employee with confidential information and the employer later provides the confidential information. The non-compete becomes enforceable not at the moment the employee signs the non-compete, but at the moment the employee receives the confidential information.

So, if the employer provided confidential information, the ancillary requirement is satisfied, and the non-compete is potentially enforceable (if it’s reasonable). If the employer did not provide confidential information, the ancillary requirement is not satisfied, and the non-compete is unenforceable.

Of course, it’s usually not that simple. You might occasionally get a case where, say, the employee signed a non-compete but quit a few days later, without receiving any information. But in the vast majority of cases the employee received some information from the employer that is at least arguably confidential. It may be as simple as learning the company’s prices, the identity of the company’s customers, and information about the customers.

This is where the rubber meets the road. Is the ancillary requirement satisfied when the employee simply received the same kind of basic information that employees always receive?

This is the unanswered question, and there are two views.

The employer’s argument focuses on a short but important sentence from the Sheshunoff opinion. Addressing the “ancillary to an otherwise enforceable agreement” element of the statute, the Sheshunoff court said:

Concerns that have driven disputes over whether a covenant is ancillary to an otherwise enforceable agreement—such as the amount of information an employee has received, its importance, its true degree of confidentiality, and the time period over which it is received—are better addressed in determining whether and to what extent a restraint on competition is justified.

Id. at 655-56.

Let me translate. The court is saying let’s not sweat the details about the confidential information when we’re applying the “ancillary” requirement of the statute. We can worry about the details when we apply the second requirement of the statute, reasonableness.

So, for example, if the employee only received a tiny bit of information, or if the information was not highly confidential, the court can consider that in determining whether the scope of the non-compete is reasonable.

The implication is that the amount of information, its importance, and its “true degree of confidentiality” don’t make a difference to whether the non-compete is “ancillary to an otherwise enforceable agreement.” One could interpret Sheshunoff to mean that, for the purpose of the ancillary requirement, it’s enough to show that the employee received a little bit of confidential information, and the information doesn’t have to be that confidential, or even important.

The trouble with this interpretation is that it threatens to render the statute’s “ancillary” requirement effectively meaningless. That brings me to the employee’s argument.

It don’t mean nothin’

In practice, the employee will almost always receive information that the employer claims is confidential. Let’s take a typical sales position. A sales person is always going to receive information about who her customers are, how much they pay, and what they buy. Usually you can’t get all that information just by Googling it. But it’s not the secret formula to Coke, either. The sales person could probably put together the same information using a web browser and a telephone.

The employee’s argument is that it’s not enough to show the employee received information that the employer can plausibly argue was confidential. The employer has to prove the information provided to the employee was actually confidential. This simply follows from Sheshunoff’s requirement that the employer prove that it performed its promise to provide the confidential information.

It cannot be enough, this argument says, for the employer merely to recite the “magic words” in the agreement and then say that the information is confidential. That would make the ancillary requirement virtually meaningless, and we should not assume the legislature included the ancillary requirement for no reason.

In other words, the requirement of providing confidential information must have some teeth to it.

This was the view of the federal district court in the recent case Miner, Ltd. v. Anguiano, No. EP-19-CV-00082-FM, 2019 WL 2290562, at *9 (W.D. Tex. May 29, 2019). The employer argued that the employee, an account executive, was privy to confidential information because the confidential information was required for the work to be performed. At the preliminary injunction hearing, the employer said “the confidential information includes things like business strategy, where are we going, pricing information, margins.”

That sounds like plausibly confidential information. But the court was not having it. “Plaintiff has not persuaded this court that this case involved the dissemination of ‘confidential information.’”

The district court cited DeSantis v. Wackenhut Corp., 793 S.W.2d 670 (Tex. 1990), where “the Texas Supreme Court rejected the plaintiff’s claim that its supposed confidential information—the identity of their customers, pricing policies, cost factors, and bidding strategies—was protectable under the confidentiality agreement.” The court in Wackenhut explained that the plaintiff “failed to show 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.”

Applying Wackenhut, the federal district court found that the employer had failed to make a strong enough case that the information it provided the employee was truly confidential:

Like Wackenhut, Plaintiff has not shown its business practices, pricing, margin, or strategy were uniquely developed or not readily accessible. Furthermore, Plaintiff’s alleged “confidential information” is vague at best. Plaintiff struggles to identify and expand upon the alleged confidential information. The court will not infer a fact into existence. The Employment Agreement lacks consideration and is unenforceable.

Finding the non-compete unenforceable, the court in Miner, Ltd. v. Anguiano declined to issue a preliminary injunction to enforce it. (The court granted a preliminary injunction on other grounds.)

The quoted section from Miner suggests that application of the “ancillary” requirement in Texas non-compete litigation still raises a fundamental question: how confidential is “confidential”?

The Sheshunoff opinion said don’t worry too much about the “importance” or “true degree of confidentiality” of the information at issue. But Miner suggests that Texas judges are not going to assume the information is confidential just because the employer says it is. At least not until the Texas Supreme Court says they have to.

Like Richard Marx said, I’ll be right here waiting.

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Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC.

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

Ethics Tips for Law Bloggers

I know what you’re thinking. “A blog post about blogs? Wow, Five Minute Law has really jumped the shark.”

But if you’re a lawyer who blogs, a lawyer thinking about blogging, or just someone who reads lawyer blogs, I think you’ll find these ethics tips worthwhile. And so “meta.”

If you also want practical tips on lawyer blogging, check out my UT Law CLE webcast with legal marketing expert Stacey E. Burke, Lawyer Blogging: Ethical Issues and Practical Tips.

These tips focus on Texas ethics rules, because that’s where I practice, but other states have similar ethics rules, so read on, non-Texas lawyers.

Ethics Tip #1: Don’t imply an attorney-client relationship

There are two things you don’t want your blog post to do: form an attorney-client relationship or provide legal advice.

Forming an attorney-client relationship requires that the client communicate an intent that the lawyer provide legal services and that the lawyer consent to do so. The grey area is that the lawyer’s consent can be express or implied. Implied consent happens when the lawyer knows or reasonably should know that the client is reasonably relying on the lawyer to provide the services.

It is unlikely that a person would form an attorney-client relationship by reading a lawyer’s blog post. No one reading a blog post would reasonably think “that lawyer just agreed to provide me with legal services.”

But sometimes people are unreasonable. So be careful not to write anything that implies you are agreeing to provide the reader with legal services. And if you want to be extra cautious, include a disclaimer. On my YouTube channel, for example, I say “Zach Wolfe is not your lawyer (unless you have signed an engagement agreement with his firm).”

The danger of an inadvertent attorney-client relationship is greater in the comments section. Imagine a reader comments, “thanks for the helpful post about non-competes” and then asks if you think his non-compete is enforceable. (Something like this has happened to me.) Don’t ignore the comment, but make sure your response does not imply that you have agreed to be that guy’s lawyer.

The second thing to avoid is related, but thornier: legal advice. It’s related because if the person reading your blog post is not your client, then generally you can’t be held responsible for giving that person bad legal advice. It’s thornier because the whole point of many blog posts is to give guidance based on your expertise. Of course it’s legal advice, in a sense.

So there is no perfect solution to this problem, but it is a good practice to include a disclaimer. The best disclaimer I’ve seen was on a Twitter profile: “Expressly incorporates all disclaimers of all Twitter lawyers everywhere.”

But seriously, a disclaimer can clarify that your expert analysis is not legal advice for anyone’s specific situation. Again, that should be obvious, but it doesn’t hurt to say it.

Ethics Tip #2: Be aware of potential issue conflicts

You know you have arrived as a law blogger when opposing counsel cites a statement from your blog post against you in the courtroom. That is the greatest compliment.

But this points out a risk that makes lawyers nervous about expressing opinions on legal issues: issue conflicts. There is always the risk that an opinion in your blog post could conflict with the position of your client in a present or future case. The situation is analogous to “issue conflicts” that can arise when a lawyer advocates for conflicting positions in different litigations.

Considering this danger of issue conflicts, law bloggers have essentially three choices:

Never express an opinion on a legal issue; it could be cited against you.
Say whatever you want; it’s just your personal opinion.
Express educated opinions about legal issues in your practice area, but be careful how you do it.

Choice 1 strikes me as overly cautious. If you’re that risk averse, then blogging probably isn’t for you in the first place. And if you are blogging, one of the best ways to develop a reputation as a “thought leader” in your practice area is to express opinions. You’re a blogger, not a reporter.

But Choice 2 goes too far the other way. I respect the attitude of saying whatever the heck you think, but if you want to get and keep clients, you should at least consider how your opinions could impact clients and potential clients.

The prudential considerations are obvious. Your client probably won’t be happy if you express an opinion directly adverse to the client’s position in a pending lawsuit. In some cases, the issue conflict might even present an ethical issue.

The rules on issue conflicts are fuzzy. Here is comment 24 to Model Rule 1.7 on conflicts of interest:

Applying this to law blogs, we essentially get the following rule: a lawyer taking an inconsistent position in a blog post is generally not a conflict of interest, except in the rare case where it would materially limit the lawyer’s effectiveness in representing the client.

So it depends. Let’s take three different opinions as examples:

Texas should only allow non-competes in the sale of a business.
Under Texas law, the employer has the burden to prove that a non-compete is reasonable.
The Texas Citizens Participation Act (TCPA) applies to a claim that an employee misappropriated trade secrets.

These are different types of opinions. No. 1 is a personal opinion about what the law should be. No. 2 is a plain-vanilla statement about what the law is. No. 3 is somewhere in between.

I doubt that expressing a personal opinion about what the law should be would ever violate an ethical duty to a client, especially when the First Amendment is factored in. If you’re prosecuting a drug offense and the defense attorney cites your public statement that marijuana should be legalized, the response is easy: that was just my personal opinion. It’s a free country.

But exercising your freedom of speech could present a practical problem. If your practice is defending medical malpractice claims, your clients probably won’t be too excited if you publish a blog post opining that caps on pain and suffering damages in med mal cases should be abolished.

The second kind of statement—simply stating what the law is on a basic issue—is also unlikely to create an ethical issue. That is, unless you take a contrary position in court. Let’s say I write a blog post saying the statute of limitations for a certain claim is four years, and then in court I say it’s two years. That kind of stark conflict is going to hurt my credibility.

The solution to this problem is fairly simple: be accurate in your statements about what the law is, and don’t take unfounded positions in court.

Opinion 3 is a harder case. When you express an opinion about an unsettled question that is troubling the courts, you could say it’s just your personal opinion. And judges should understand the difference between your personal opinion on a difficult legal issue and your role as an advocate for your client.

But the reality is that many judges are more formalistic in their thinking. If the judge thinks there is only one “right” answer to the legal issue, your conflicting statements about that issue could weaken your position in the eyes of the court. One could argue that “materially limits” your effectiveness in the lawsuit.

Assuming your opinion could hurt your client—even if it shouldn’t—do you violate an ethical duty to your client if you express an opinion on an unsettled legal issue that goes against your client’s position? Generally, I say no.

But that’s just my opinion, man.

Ethics Tip #3: Don’t say you “specialize”

After that difficult issue, let’s go to a simple rule.

Texas Rule of Professional Conduct 7.04 generally prohibits lawyers from saying they “specialize” in a certain area of law. There are exceptions, most notably if you are certified by the Texas Board of Legal Specialization. Unless you fit one of the exceptions, you should not say that you “specialize” or that you are a “specialist.”

Texas lawyers break this rule more often than you might think. If I see a Texas lawyer say in a blog post that he “specializes” in some area of law that I know the Texas Board of Legal Specialization doesn’t recognize as a specialty, I’m going to raise an eyebrow.

The solution to this problem is also simple. Just don’t use the word “specialize.” Say that your practice “focuses” on a certain area of law, and you should be fine.

Does this put form over substance? Sure, but the Texas State Bar seems to be comfortable drawing the line here.

Ethics Tip #4: Remember that a client’s “confidential information” includes non-confidential information

This may be the most counter-intuitive tip.

Suppose you represent a client in a bitter business dispute that goes all the way through trial and appeal. There’s a transcript of the trial testimony on file with the trial court, plus an appellate court opinion detailing the sordid facts of the case. So you’re free to write about the facts in a blog post without client permission, right? I mean, it’s “public record.”

Not so fast. Look at Texas Rule of Professional Conduct 1.05(a). “Confidential information” includes both “privileged information” and “unprivileged client information.”

Privileged information is easy to understand. But the definition of “unprivileged client information” is surprising: “all information relating to a client or furnished by the client, other than privileged information, acquired by the lawyer during the course of or by reason of the representation of the client.”

Read that again. Confidential information includes all unprivileged information:

relating to a client or furnished by the client and
acquired “during the course of” or “by reason of” representation of the client.

This is an extraordinarily broad definition. It doesn’t matter whether the information is publicly available. If the information “relates” to the client and you obtained it during the course of the representation, it’s confidential.

That means, generally, you can’t publish such information in a blog post. Rule 1.05(b) says a lawyer may not “reveal” confidential information or “use” confidential information to the client’s disadvantage.

There are, of course, exceptions, e.g., when “the client consents after consultation.” See Rule 1.05(b) and (c). But the bottom line is that in most cases if you want to say anything about a client’s case in a blog post, you’re going to have to get the client’s informed consent.

Can this be right? The press is free to write an article discussing all the facts of a case that are available in the public record. But if I represented one of the parties to the case, you’re telling me I can’t blog about the facts, even when I’m portraying my client in a positive light.

Here’s a possible solution: You could make a case that you’re not violating client confidentiality by focusing on the rule’s use of the word “reveal.” Implicit in the word reveal is the idea that you are communicating something not already known.

That’s the textualist case for allowing lawyers to blog about the facts of their cases. And there’s a non-textualist argument as well: surely, despite the literal language of the rule, a common-sense interpretation would allow a lawyer to write a blog post that discusses facts that have already become public, provided the discussion doesn’t disadvantage the client.

Maybe, but don’t expect help from the American Bar Association. ABA Formal Opinion 480 on lawyer blogging says the rule means what it says: lawyers cannot blog about “unprivileged confidential information” without permission, even if the information is not really confidential.

Unless an exception applies, the ABA says “a lawyer is prohibited from commenting publicly about any information related to a representation.” And it doesn’t matter if the information is in the public record: “information about a client’s representation contained in a court’s order, for example, although contained in a public document or record, is not exempt from the lawyer’s duty of confidentiality.”

There’s one obvious solution: just get client consent. But it can be awkward to contact a client or former client every time you want to include a little war story in your next blog post.

There’s an easier way to avoid disclosing “unprivileged confidential information.” Just don’t name names. When you describe the facts of a case you’ve handled, don’t name the parties. Just describe the situation generically, or as a hypothetical.

This will sometimes solve the problem, but be careful. As the ABA opinion points out, if your description is specific enough that the reader can figure out who you’re talking about, you may still be violating the confidentiality rule. “A violation is not avoided by describing public commentary as a ‘hypothetical,’” the opinion says, “if there is a reasonable likelihood that a third party may ascertain the identity or situation of the client from the facts set forth in the hypothetical.”

And hypotheticals can sound like real cases, especially when you handle the same type of case over and over. When I describe a hypothetical departing employee lawsuit, I sometimes wonder if a former client might think I’m talking about him, only because the fact patterns tend to be so similar.

Here again, a disclaimer may be helpful. On my LinkedIn profile, for example, I say: “Hypotheticals are based on my general experience and reading, not particular actual cases.”

Ethics Tip #5: File your blog post if it contains “advertising”

Texas lawyers must file any advertisement in the public media with the Advertising Review Committee of the State Bar. See Rule 7.07(a). So lawyer bloggers have two options: put as much advertising as you want in your blog post and file it, or avoid saying anything in your blog post that will turn it into advertising.

Simultaneous filing with the State Bar is a pain (and there is a fee), so most lawyers will opt for the latter. But when is a blog post considered advertising?

The Texas ethics rules don’t expressly define “advertisement” or “advertising.” But the State Bar has provided guidance in Interpretive Comment 17: “Blogs or status updates considered to be educational or informational in nature are not required to be filed.”

So if you’re trying to avoid making your blog post an advertisement, “educational or informational” is your mantra. To avoid an ethical issue, you should aim to educate and inform your audience, not to brag about yourself. And this usually makes for a better post anyway.

But even when you’re trying to educate and inform, it’s easy to stray into content that could be considered advertising.

Here are three things likely to turn a lawyer’s “educational or informational” blog post into advertising:

Promoting good results obtained for a client
Touting the lawyer’s experience or qualifications
The “call to action”

Trouble is, these are natural things to do in a blog post. A good result you recently obtained for a client is a classic blog post topic. Talking about your experience and qualifications is also natural. And many marketing experts say your content should conclude with a “call to action,” e.g. “if you’re facing a difficult divorce, call me now at the number below.”

The first two things that can make your blog post an advertisement are matters of degree. If you write about a result obtained for a client, do it in a way that is educational, without expressly using it to promote yourself. Similarly, you can convey information about your experience and qualifications in a subtle way. In both cases, the key concept is “show, don’t tell.” Show the readers that you understand a particular area of law.

The call to action is different. In my opinion, any post that includes a call to action is crossing the border into Advertising-Land. So you’ve got two choices. Either don’t include the call to action, or include it and just deal with the hassle of filing your blog post with the State Bar.

There’s one more thing that is likely to make your blog post an advertisement: comparing yourself to other lawyers. That brings me to the next tip.

Ethics Tip #6: Don’t compare yourself to other lawyers

This is another fairly simple one. Rule 7.02(a)(4) of the Texas Disciplinary Rules provides that a lawyer may not compare the lawyer’s services with other lawyers’ services, “unless the comparison can be substantiated by reference to verifiable, objective data.”

It’s a rare comparison that can be backed up with verifiable, objective data. So, if you can document that “I’ve tried more mesothelioma cases to verdict in Jefferson County than any other practicing lawyer,” then have at it. If you know for a fact that “I’m one of only nine Texas lawyers board certified in both Real Estate Law and Civil Trial Law,” then I suppose you can say that.

But just about any opinion comparing yourself to another lawyer is going to be off limits. By definition, if it’s an opinion it probably cannot be proven with “verifiable, objective data.”

Comment 5 to Rule 7.02 gives some examples of unsubstantiated opinions: “we are the toughest lawyers in town,” “we will get money for you when other lawyers can’t,” or “we are the best law firm in Texas if you want a large recovery.”

Never mind if you see lawyers making statements like this all the time. Don’t do it in your blog post. In addition to violating Rule 7.02, it also risks turning your blog post into an advertisement, as discussed above.

Plus, who wants to read a blog post where a lawyer just boasts and compares himself to other lawyers? That’s almost as bad as a blog post about blogging.

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Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who focuses—he didn’t say “specialize”—on non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. He expressly incorporates herein all disclaimers of all law blogs everywhere.

Turn Out the Lights, the Party’s Over: Texas Legislature Takes All the Fun Out of the TCPA

Back in my day, there was only one night when you could watch NFL action: Monday. Once Don Meredith started signing “Turn Out the Lights . . .” that was all the pro football you were going to get until the next Sunday. There was no “Thursday Night Football,” or even “Football Night in America.” And we liked it.

The other thing we did back in the good old days, meaning roughly 2017 until now, was file a TCPA motion to dismiss in a lawsuit that wasn’t really about “freedom of speech” or “freedom of association,” at least not in the First Amendment sense. Like a non-compete or trade secrets case.

That was fun, but business lobbies and the Texas legislature were not so amused. They mobilized to pass House Bill 2730 which, like the proverbial Federal Reserve raising interest rates, takes away the punch bowl just when the party gets going.

In broad terms, the amendment to the TCPA does three things:

First, it exempts certain types of claims from the TCPA, most notably non-compete and trade secrets claims. I may be biased, considering that is the focus of my litigation practice, but I see this as the most significant change.

Second, the amendment changes the TCPA’s broad definitions of the right of association and the right of free speech that led to such widespread use of the statute. It does not go so far as making those definitions synonymous with constitutional rights. But the previous definition of the key term “matter of public concern,” which was broad and vague, has been replaced with a definition that is significantly different—but still broad and vague.

Third, HB2730 changes the procedures for TCPA motions. For example, the statute now requires 21 days’ notice of a hearing on a TCPA motion, establishes a response deadline seven days before the hearing, and tweaks the rules for awarding attorney’s fees and sanctions. These changes will be important for practicing Texas litigators to note but probably won’t have any significant public policy impact.

The amendments take effect September 1, 2019 and are not retroactive. The previous statute will continue to apply to suits filed before September 1.

You can view the text of HB2730 here, and I have created a handy redlined version of the changes to the TCPA’s definitions that you can view here.

That’s all I’m going to say about the specific changes to the TCPA, because they are relatively self-explanatory, and I’m sure there will be no shortage of articles exploring the nooks and crannies of the textual changes.

I want to focus on some larger questions, like these:

Does the amended TCPA now do a better job of solving the problem it was intended to solve? (Sort of.)

Would it have been better for the legislature to scrap the whole statute? (Probably.)

Is the new exemption for non-compete and trade secrets claims a good idea? (It depends.)

What does this change mean for Texas non-compete and trade secrets law more generally? (Perhaps the time has come for “non-compete reform” in Texas.)

At the risk using a trendy corporate buzzword, let’s “drill down.”

The Empire SLAPPs Back

First, does the TCPA now solve the problem it was intended to solve?

To answer that question, we have to figure out what the problem was. People call the TCPA an “anti-SLAPP” statute. SLAPP stands for Strategic Lawsuit Against Public Participation. So, apparently there was a Strategic-Lawsuit-Against-Public-Participation crisis in Texas before the TCPA.

Funny thing is, in over 20 years of Texas litigation practice, I’ve never seen a SLAPP in my practice. I don’t think I know anybody who has handled one. I probably know more people who have spotted Sasquatch than people who have seen a true SLAPP.

Don’t get me wrong, I’m sure SLAPPs exist, just like Bigfoot. But here’s the odd thing. Think back to 2010, the year before the TCPA was passed. To jog your memory, the no. 1 song that year was by Ke$ha, who was still using that dollar symbol in her name. Remember how in 2010 Texans across the state were terrified to speak their minds about issues of public concern? Remember how business in Texas courthouses ground to a halt under an avalanche of SLAPP lawsuits?

Yeah, I don’t remember that either. I’m just not convinced that SLAPPs were ever really “a thing.”

But obviously someone was concerned about SLAPPs. Legislators don’t just pass new laws without getting something in return.

I would bet that big media companies had something to do with it. That’s just a guess, but an educated guess.

It would fit a familiar pattern. When doctors and their insurance companies got tired of nuisance medical malpractice suits, they pushed the legislature to pass the Texas Medical Liability Act. When builders got tired of nuisance homeowner lawsuits, they pushed for passage of the Texas Residential Construction Liability Act. You get the idea.

I’d bet that media companies got tired of nuisance lawsuits claiming defamation and wanted the legislature to do something about it. And because the ostensible purpose of the statute was to protect First Amendment rights, they got free speech groups on board.

Don’t get me wrong, I’m all about the First Amendment. In my younger, wilder days I was even labeled the “free speech extremist” in a college seminar. But I always thought the best legal defense to an attack on First Amendment rights was, you know, the First Amendment.

Call me old-fashioned, but I like the notion that the rules of the civil litigation system ought to be the same for all kinds of lawsuits. And if you take that idea seriously, it means sometimes saying no to special-interest exceptions, even when the special interest seems like a deserving one.

Otherwise, you get civil litigation rules that look like the US Tax Code: encrusted with the barnacles of special-interest exemptions.

Hey, I get it. That’s how politics works. Special-interest protections are just the way the game is played and the sausage gets made. But us practicing litigators don’t have to like it, or pretend like it’s a good thing.

And then there’s the more practical problem with special-interest legislation: the unintended consequences. The TCPA’s definitions were so broad that people started filing TCPA motions in cases the legislature probably never intended, like trade secrets cases. See A SLAPP in the Face to Texas Trade Secrets Lawsuits – Part 1.

This did not sit well with Chamber of Commerce types. Business groups were fine with the TCPA in theory, because most businesses have better things to do than filing SLAPPs against defenseless consumers. But businesses do like to file lawsuits when their employees leave to join competitors. So when defendants started filing TCPA motions in non-compete and trade secrets lawsuits, you knew the “pro-business” groups and politicians would not be happy campers.

I put “pro-business” in quotes to question whether favoring lawsuits against employees who join competing companies is really pro-business. Usually there are two businesses involved in such a dispute: the business the employee left, and the business the employee joined. What is the real “pro-business” position in such a case, a government decree prohibiting the employee from working for a competitor, or letting the employee go where the market demands?

It would be an interesting experiment to see what would happen to business in a state if non-competes for at-will employees were generally prohibited. Would companies in that state stop investing in innovation and human resources, fearful that their investments would be wasted?

Ideally, the experiment would involve a a state that has no political or ideological baggage, like California, the world’s fifth-largest economy.

Alas, the real world is not a laboratory, so there’s no way to know for sure. But here’s a hypothesis: if Texas really wanted to favor competition and innovation, it would prohibit non-competes except in narrow circumstances like the sale of a business.

Politically, that doesn’t seem to be in the cards. For whatever reason, business groups tend to take a short-sighted, conventional view of their interests, so they like enforcement of non-competes. Carving non-compete suits out of the TCPA is the latest proof of that.

Two Wrongs Don’t Make a Right

So now we have a special-interest statute, the TCPA, with a special-interest exception, non-compete and trade secrets claims. Which one was the mistake, the original statute, or the exception?

I think you can make a case that the legislature went wrong both times. The original TCPA was ill-conceived and had language going far beyond the purported basis for the statute. You could make a good case for just scrapping the whole thing.

But if we’re going to have an anti-SLAPP statute, I don’t see why it shouldn’t apply to departing employee lawsuits. Granted, that’s probably not the kind of lawsuit legislators had in mind when they voted for the TCPA. But a non-compete or trade secrets suit is just as likely to raise “SLAPP” concerns as any other kind of lawsuit.

Mind you, I’m not bashing plaintiffs in departing employee lawsuits—I’ve represented them and will continue to do so. But any lawyer who handles non-compete cases knows there are plenty of cases of non-compete abuse.

Here’s a common scenario: a high-performing salesperson gets fed up with her job and decides to make a fresh start working for a competitor. She’s careful not to poach any customers from her first employer, but the first employer is still angry. So even though her non-compete is too broad to hold up in court and her industry doesn’t have any real secrets, the first employer sues her for breach of non-compete and misappropriation of trade secrets. They have deeper pockets and want to “send a message.”

Texas already has procedures for dismissing groundless lawsuits, but that won’t do this employee much good, because the employer’s claims are not entirely groundless.

No, what the employee needs in this situation is some way to contest the merits of the employer’s claims early in the lawsuit, before getting buried under a mountain of legal fees. Maybe a procedure where the employee files a motion that requires the employer to offer evidence to support its claims before the employee has to endure the expensive discovery process?

Ok, never mind. That would be crazy. Kind of like pro football on Thursday nights.

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Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. He has the original Monday Night Football theme on his iTunes.

“Direct Access” to Computers in Departing Employee Litigation

Imagine a criminal case where the government sends the defendant’s lawyer a request to produce emails between the alleged conspirators, bank records showing payments to the defendant’s offshore account, or a recording of a key meeting. You wouldn’t expect to get much, would you? That’s why we have search warrants.

Civil litigation is different. In a civil case, the system largely relies on the parties themselves to search for and produce documents that the requesting party can then use to prove its case. Generally, you don’t get to search the opposing party’s office for relevant documents.

The same general rule applies to computer files: you don’t get to search the other side’s computers or other devices. There are exceptions, but the Texas Supreme Court has set the bar high for obtaining an order authorizing “direct access” to an opposing party’s electronic files.

In In re Weekley Homes, 295 S.W.3d 309 (Tex. 2009), the court held that intrusive measures such as direct access to a computer or other electronic storage device require, at a minimum, that the benefits of the discovery outweigh the burden imposed. Permitting direct access “is particularly intrusive and should be generally discouraged,” the court said, “just as permitting open access to a party’s file cabinets for general perusal would be.” To obtain direct access, “the requesting party must show that the responding party has somehow defaulted in its obligation to search its records and produce the requested data.”

More recently, the Texas Supreme Court applied Weekley in In re Shipman, 540 S.W.3d 562 (Tex. 2018). The court held that the responding party’s late production of responsive documents and testimony that some files had been deleted years earlier was insufficient to justify direct access. The responding party testified by affidavit that he had searched both electronic and paper files and produced all responsive documents, and the requesting party made no showing that the responding party was incapable of searching his computer.

Weekley Homes and Shipman were not “departing employee” cases—the type of case I handle most often—but direct access is an important issue in departing employee litigation. Let’s look at the transcript of a hypothetical hearing to see how these cases might apply in a typical departing employee case.

Hearing Transcript

Judge Lansing: Alright, next case up is Cause Number 19-24601, Paula Payne Windows v. Dawn Davis. Mr. Livingston, who are you here for?

Livingston: Good morning, judge. I’m here with Phil Hamilton for the plaintiff on a motion to compel.

Reynolds: Maria Reynolds here for the defendants, Your Honor.

Judge: Good morning, Ms. Reynolds. Was there a response to the motion?

Reynolds: Yes, we filed a response yesterday.

Judge: Well if I can get this computer on, maybe I can pull it up. Can you . . .

Reynolds: I have a binder with the motion and response if that would make it easier.

Judge: Sure, I’ll take your binder. This looks like a lot of material. Have y’all talked about this already?

Reynolds: Not really. All I got was an email from Mr. Hamilton demanding we turn over Ms. Davis’s laptop. That’s part of the problem, we’ve been trying . . .

Hamilton: Your Honor, that’s not exactly right. We talked about these issues at Ms. Davis’s deposition. That’s when she said . . .

Judge: Ok, well, I’ll hear your arguments on the motion. But first back up a little and remind me what this case is about. Mr. Hamilton?

Hamilton: Yes, of course. This is a case about theft of trade secrets. Dawn Davis worked for my client, Paula Payne Windows, for five years. She was very well paid. She rose up their top sales position, and she had access to all of their confidential information and trade secrets. Then about six months ago she suddenly left and went to work for a competitor, and that’s the other Defendant, Real Cheap Windows.

Judge: Ok, I remember this case now. But what kind of trade secrets does a windows company have?

Hamilton: There are two things we’re most concerned with, Your Honor. First, Paula Payne has a Master Customer List spreadsheet that has detailed information about every one of their customers. Second, for each customer there is a Sales History spreadsheet that has every sale including price, quantity, date, margins—everything a competitor would need to try to undercut my client.

Judge: I see. So you want me to compel Ms. Davis to produce those documents?

Hamilton: Actually, you already did that. If you take a look at tab C, that’s your order requiring Defendants to produce “all documents Davis received from Paula Payne during her Employment Period, including all customer lists and sales records.” We’re asking you to order her to produce her laptop so our forensic expert can see if our Master Customer List and Sales History spreadsheets were on it.

Judge: Ok, hold that thought. I want to hear from Ms. Reynolds.

Reynolds: Thank you, judge. I’ve been biting my tongue. This is an outrageous demand for direct access to my client’s computer. It is no different than a request to rifle through her file cabinets.

Judge: Well hold on, let’s take this one step at a time. Did your client comply with my previous order?

Reynolds: Absolutely. Ms. Davis searched her home office and produced a banker’s box full of documents. But she didn’t find any customer list or sales history documents. Now they’re asking for native Excel files, but they never specifically requested those. If I could approach, here is a copy of Rule 196.4:

Judge: What the hell is “magnetic” data?

Reynolds: Honestly, judge, I think that was a little before my time, but the issue here is electronic data. Paula Payne wants to search my client’s computer for electronic files, like Excel spreadsheets, but they never specifically asked for electronic files.

Hamilton: Actually, we did. This is from our First Request for Production:

Judge: That’s pretty general. Wouldn’t it be better practice to include the electronic files you want in the specific request for production? You could have said “including native Excel spreadsheets and other electronic files” in your request, right?

Hamilton: We could have, Your Honor, but the two leading cases on this, Weekley Homes and Shipman, both say it’s sufficient if we clarify in our motion to compel that we’re asking for electronic files. Here is an excerpt from Shipman, citing to Weekley:

Hamilton: The situation here is the same. Our definition of “documents” included electronic files, and our motion makes it abundantly clear what we’re asking for.

Judge: Ok, I think you’ve sufficiently asked for computer files, so let’s talk about direct access. What’s your basis for that?

Hamilton: We are allowed to obtain direct access to an electronic device if we “show that the responding party has somehow defaulted in its obligation to search its records and produce the requested data.” That’s straight out of Shipman, quoting from Weekley. And that’s exactly what we have here. After Ms. Reynolds produced the box of hard copy documents, we sent her a letter pointing out that her production did not include any electronic files, and we specifically asked if Ms. Davis had searched her laptop. She responded in an email and said “my client has conducted a reasonably diligent search and has produced all responsive non-privileged documents.”

Judge: So she doesn’t have the documents. What’s the problem?

Hamilton: Later we took Dawn Davis’s deposition, and here’s what she said:

Hamilton: It’s obvious from her evasive answers that she did not conduct a diligent search of her laptop for the documents we requested, even after we specifically inquired about electronic files. That’s a default in her obligation to search her records and produce the requested records.

Judge: Alright, let me hear from Ms. Reynolds on this.

Reynolds: Your Honor, there is no default. This case is just like Weekley and Shipman, where the Texas Supreme Court ruled against direct access. In Weekley the court said you cannot rely on “mere skepticism or bare allegations that the responding party has failed to comply with its discovery duties.” That is all we have here, just mere skepticism and speculation. There is no proof that Ms. Davis failed to search her laptop.

Judge: Mr. Hamilton, how is this case any different from those cases?

Hamilton: It’s totally different. Weekley was about whether deleted emails were specifically requested; that’s not our issue. Shipman was a case about late production. Here is an excerpt from Shipman with its key facts:

Hamilton: So there are two key differences. First, Shipman searched his computer and produced documents he found. Second, Shipman signed an affidavit specifically stating that he searched his computer files and produced all responsive documents. We don’t have either one here.

Judge: Ms. Reynolds, do you have an affidavit from your client saying she searched her computer?

Reynolds: No, Your Honor. But that’s not my burden. If you look closely at Shipman, the court made it clear that the requesting party has the burden to prove that the responding party has defaulted on its discovery obligations. “Mere skepticism” doesn’t meet their burden:

Reynolds: It’s the same thing here. Paula Payne hasn’t offered any evidence that my client is incapable of searching her computer or that she hasn’t conducted a diligent search. You have to say no to this.

Judge: What about her deposition testimony? Isn’t that evidence she didn’t do a diligent search.

Reynolds: She said she wasn’t sure if she transferred the customer list or sales histories to her laptop. That’s just like Shipman. The court said that Shipman’s “equivocation about the existence of discrete documents at his deposition” did not “transform general skepticism into discovery default.” Shipman was asked about “discrete, individual documents” from more than five years before the deposition and stated he was “unsure if they existed.” My client’s testimony was similar.

Judge: I understand, but did she search her computer? The defendant in Shipman signed an affidavit that specifically said he searched both electronic and hard copy records.

Reynolds: I don’t know all the details of her search. She has stated that she conducted a diligent search and produced all the responsive documents she found. If Paula Payne wants to ask her about all the little details, they can do that in a deposition.

Hamilton: Your Honor, we tried! We asked . . .

Judge: You can sit down, Mr. Hamilton. I’ve heard enough. I’m going to grant the motion to compel and order Ms. Davis to turn over her laptop to Paula Payne’s expert. Counsel are to confer on the details of a forensic protocol and put it in a proposed order. If y’all can’t work that out, come back and see me.

Reynolds: Your Honor, I really think it would be error to do this. The Texas Supreme Court has been clear.

Judge: Well that’s my ruling. And if y’all have to take it up to the Court of Appeals on mandamus, I won’t be offended. Good to see all of you. Even you, Mr. Livingston [laughter in courtroom]. So did you catch any bass last weekend?

Livingston: I’m afraid not. Nothing biting last weekend except the mosquitoes.

Judge: Well that’s too bad. Anyway, give Connie my best.

Livingston: Thank you, judge, I’ll do that.

Judge: Alright, everyone can be excused.

What Did We Learn Today?

So what do you think? Did Judge Lansing correctly apply Weekley and Shipman? Was there sufficient evidence that Davis defaulted on her discovery obligations? What should Dawn Davis’s lawyer have done differently? Could Paula Payne’s lawyers draft a better request for production? Did they handle the deposition well?

Give me your thoughts before Wednesday, when I’m presenting Dude, Where’s my USB Drive? Forensic Issues in Departing Employee Litigation for Pathway Forensics. It should be almost as much fun as a motion to compel hearing.

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Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC.

Federal-Style Motions to Dismiss May Finally Come to Texas

What a Difference a Word Makes

Are you a Texas business, or a lawyer who represents Texas businesses? Get ready for federal-style motions to dismiss to become routine in state court litigation.

As reported here, the Texas House of Representatives recently passed House Bill 3300. With the change of a single word, the bill could bring the biggest change to Texas litigation practice since the adoption of the “new” discovery rules in 1999.

The bill would change Texas Rule of Civil Procedure 91a from “the court shall award costs and reasonable and necessary attorney’s fees to the prevailing party” to “the court may award costs and reasonable and necessary attorney’s fees to the prevailing party.”

This is important. It was already a big deal when the legislature originally mandated motions to dismiss in 2011, leading to the adoption of Rule 91a in 2013. For the first time, the Texas Rules authorized motions to dismiss groundless lawsuits. This moved Texas procedure closer to the more defendant-friendly practice in federal court.

But Texas defense lawyers largely refrained from filing motions to dismiss under Rule 91a. The rule had a “loser pays” provision requiring an unsuccessful movant to pay the responding party’s attorney’s fees. If you’re a defense lawyer, the last thing you want to tell your client is “sorry, we lost the motion and you’re going to have to pay the other side’s attorney’s fees.”

The new version of Rule 91a passed by the House would change that. If enacted, the change would give the judge discretion not to award attorney’s fees, making defendants much more likely to file motions to dismiss.

Want proof? Just look at all the motions to dismiss filed under the Texas Citizens Participation Act (TCPA), also enacted in 2011. That statute authorized motions to dismiss in certain cases but did not require the moving party to pay attorney’s fees if the judge denied the motion. This resulted in a tsunami of TCPA motions. More about that later.

To appreciate the significance of the change to Rule 91a, let’s back up a bit. Since the Swing Era, Federal Rule of Civil Procedure 12(b)(6) has allowed a defendant in federal court to file a motion to dismiss the plaintiff’s lawsuit for “failure to state a claim upon which relief can be granted.” This means you can ask the judge to dismiss a lawsuit—in whole or in part—on the ground that the plaintiff’s pleading on its face fails to state a valid legal claim. Most states have a similar rule.

But not Texas. Prior to Rule 91a (and the TCPA), a “motion to dismiss” was not even a thing under the Texas Rules of Civil Procedure.

There were some exceptions. You could file a motion to dismiss on the ground that Texas did not have jurisdiction over an out-of-state defendant. You could file “special exceptions” asking the court to dismiss a particular cause of action because Texas law doesn’t recognize it (like negligent infliction of emotional distress).

But outside of a few narrow exceptions like these, Texas procedure did not provide for a “motion to dismiss.”

This led to interesting conversations with non-Texas lawyers. Let’s say a New York law firm hired you as local counsel in a lawsuit filed in state court in Hidalgo County. “Should we consider filing a motion to dismiss?” the New York lawyer would ask. “Uh, we don’t really have motions to dismiss here,” you would say. “What?! That’s crazy!”

But in historical context, it was not so crazy. The absence of motions to dismiss was part of a broader Texas philosophy that every plaintiff should get his “day in court.” Traditionally, Texas law has been hostile to procedures designed to short-circuit jury trials. As the proverbial courthouse sign said, “No Spittin’, No Cussin’, and No Summary Judgment.”

Of course, that all started to change around the 1990s, with “tort reform” legislation and Republicans taking over the Texas Supreme Court. The direction of Texas law for the last three decades has been largely “pro-business” and anti-litigation. We want fewer lawsuits, and we want to dispose of them faster.

Rule 91a and the TCPA were in a sense just the latest wave in a broad effort to reign in what is seen as lawsuit abuse.

“Frivolous” Lawsuits

Is this a good thing? In theory, yes. But in practice, Rule 91a and the TCPA are trying to solve a problem that is largely unsolvable: how to quickly and inexpensively dispose of the non-frivolous nuisance case.

You may be thinking that “non-frivolous nuisance case” is an oxymoron. But it’s actually quite common. Let me explain.

First we need to distinguish between a “frivolous” lawsuit and a nuisance lawsuit. A frivolous lawsuit is the inmate claiming the prison cafeteria violated his civil rights by taking pepper steak off the Thursday night menu. It’s unreasonable on its face.

And Texas never needed a new motion to dismiss procedure to combat frivolous lawsuits. Texas already had two procedures—one in Rule 13 of the Texas Rules of Civil Procedure, the other in Chapter 10 of the Texas Civil Practice and Remedies Code—providing remedies for genuinely groundless lawsuits. But those procedures are rarely used, precisely because so few lawsuits are actually frivolous.

Most of the public doesn’t get this. They think frivolous lawsuits are common. But in over 20 years of Texas litigation practice, I don’t think I’ve had a single one.

By the way, the famous McDonald’s hot coffee lawsuit was not frivolous. I mean, reasonable people can disagree about whether McDonald’s should have been liable for keeping its coffee too hot, but the claim wasn’t frivolous. The lady wasn’t claiming she didn’t know coffee is hot. Google it.

When you think about it, it’s not surprising that frivolous lawsuits are rare. How many people are going to pay $250 an hour (at least) to have a lawyer draft and file a lawsuit that has no real chance of winning? Or how many lawyers working for a one-third cut of the recovery are going to waste their time filing a lawsuit they know will ultimately fail? Not many.

But wait, the savvy public says, you’re ignoring the fact that defendants will pay money to settle frivolous lawsuits so they don’t have to pay their lawyers to defend them. That’s why such lawsuits get filed.

Oh really? How many times have you actually seen that happen? How many insurance companies do you know that, when served with a frivolous lawsuit, say “let me get out my checkbook, how much money would you like?”

No, businesses and insurance companies are not falling over themselves to pay off plaintiffs who file groundless lawsuits. If they did, it would only encourage more.

The Problem of the Non-Frivolous Nuisance Lawsuit

Nuisance lawsuits are different. Defendants do pay to settle nuisance lawsuits, on the theory that it’s cheaper to pay a settlement than to pay your lawyer to litigate. Lawyers sometimes call these “cost of defense” settlements. And these cases are quite common.

But how are these nuisance lawsuits any different from the frivolous ones?

The difference is that a nuisance lawsuit has at least some grain of truth to it. That grain may be that if you accept the plaintiff’s allegations as true, there is at least some reasonable legal argument that the plaintiff is entitled to relief from the court. Or it may be that there is at least some evidence to support the allegations made by the plaintiff, even if nine out of ten juries would vote for the defense.

While I’ve never seen a truly frivolous lawsuit in my practice, I’ve seen plenty of nuisance lawsuits. Here are some examples, drawn from my actual experience plus a little imagination:

A homebuilder sues a competitor for copyright infringement because the competitor used a floor plan that bears numerous similarities to a floor plan the homebuilder created. The floor plan has unique features such as a large living room with a high ceiling adjacent to an open kitchen.
An employee of an oilfield services company never signs a non-compete, but when he leaves to join a competing company, his original employer sues for misappropriation of trade secrets, claiming the employee has knowledge of the company’s confidential customer list, which consists of oil and gas operators.
A consultant who was fired a couple months into his one-year contract claims he is owed an entire year of pay, when the contract expressly gave the client the option to terminate early.

These cases have two things in common: they are weak, but they are not entirely groundless.

What’s Wrong with Motions for Summary Judgment?

It’s hard to represent a defendant in this kind of lawsuit, because your client is so frustrated. “Zach, I don’t understand, why can’t we just tell the judge this claim is ridiculous?”

Sarcastic, teenage me might say “your right, that’s a great idea, I’ll just go to the judge and tell her you didn’t do anything wrong, and then the lawsuit will get dismissed!” But older, wiser me respects my clients and wants to keep them, so I explain the problem more patiently.

The problem, of course, is that lawsuits are about disputes. If we had some surefire trick to separate the good guys from the bad guys, we wouldn’t need judges, juries, and complicated rules of procedure and evidence.

“But Zach,” my client will say, “don’t they need evidence to back up their claims?” “Why can’t we tell the judge they have no evidence?”

The answer is yes, they have to have evidence, and yes, there is a procedure to tell the judge they don’t have any evidence. It’s called summary judgment. Like the Federal Rules, the Texas Rules of Civil Procedure allow a defendant to file a motion for summary judgment on the ground that there is no evidence to support the legal elements of the plaintiff’s claims. See Texas Rule 166a(i).

The benefit of a motion for summary judgment is that it avoids the time and expense of a trial. If the evidence doesn’t raise any genuine factual dispute, the judge can dispose of the case by summary judgment.

So what’s the catch? Why doesn’t summary judgment solve the problem of the non-frivolous nuisance case?

In a word: discovery.

Traditionally, the plaintiff has been entitled to take discovery before the court rules on a motion for summary judgment. Discovery includes production of documents, written answers to interrogatories, and depositions. If you’ve ever been in a lawsuit with the slightest level of complexity, you know that 90% of the time and expense is for discovery.

Oh, and there was a development around the 1990s that made the discovery process even more complicated and expensive. It was a little innovation called email.

Now the full context of Rule 91a and the TCPA is coming into focus. Discovery is time-consuming and expensive, and the proliferation of email has only made it worse. The procedures for dismissing frivolous cases (Rule 13 and Chapter 10) are not much help because so few cases are actually frivolous. The procedure for summary judgment doesn’t solve the problem because the plaintiff is usually entitled to take discovery first.

This is why people thought a Texas version of Federal Rule 12(b)(6) was necessary. You need a procedure for weeding out nuisance lawsuits before the discovery process. That’s what will cut down on the time and expense of litigation.

The Law of Unintended Consequences

Those of you who practice litigation already see where this is headed. Does a motion to dismiss procedure actually reduce the time and expense of litigation? Let’s consider a couple data points.

First, we need look no further than federal court to test the hypothesis. Here we have to be careful about our sample. We should exclude, for example, securities fraud cases. Motions to dismiss are the big event in securities fraud class actions. But there’s a special reason: Congress passed a heightened pleading standard that, essentially, requires a plaintiff to allege specific facts showing that the CEO knew he was lying when he said on the analyst call “we think the environment for our expansion into Brazil is looking positive.”

That’s unusual. In an ordinary federal case, all the plaintiff has to do is allege sufficient facts to establish a plausible basis for relief. And when a motion to dismiss is filed, the judge must assume for the purpose of the motion that those factual allegations are true. That means the vast majority of federal motions to dismiss get denied.

Mind you, this doesn’t stop lawyers from trying. BigLaw firms, especially, really like motions to dismiss. Drafting a motion to dismiss is the perfect project to assign to a less experienced litigation associate, who will then research the legal standards at issue, analyze whether the plaintiff’s pleading meets those legal standards, and draft the motion. That’s good for 5-10 billable hours (at least), not to mention the partner’s time for reviewing and revising the draft motion.

Then the plaintiff’s lawyers do the same type of thing to respond to the motion, the defense lawyers draft a reply to the response, the plaintiff’s lawyers sometimes file a “sur-reply” to the reply, the judge might hold a hearing, etc.

Bear in mind that the judge is going to deny the motion. I learned this years ago in a case before U.S. District Judge Sam Sparks. We thought there was a strong argument that one of the plaintiff’s state-law causes of action, on its face, was preempted by federal copyright law.

At a hearing Judge Sparks gruffly asked me, “why should I rule on this issue on a motion to dismiss instead of waiting for a motion for summary judgment?” My answer, in a word: discovery. I told him my client should not have to bear the expense of discovery regarding a claim that was legally defective. “Ok, you’ve got a decent point there,” he said. “Motion denied.”[1]

That kind of shows you how much Rule 12(b)(6) has reduced the time and expense of litigation in federal court.

But could the new Rule 91a be different in state court?

Again, we don’t have to speculate, because we have some data from a similar experiment. Remember the TCPA? It allows a defendant to file a motion to dismiss in certain kinds of cases (essentially any case where the claim is based on a defendant’s “communication” about a good or service). The plaintiff then has to offer evidence to support every element of his claims, before taking any discovery. So, the TCPA essentially functions as a pre-discovery motion for summary judgment.

A pre-discovery motion for summary judgment. Hallelujah! That’s exactly what we’ve been waiting for to combat the problem of the non-frivolous nuisance lawsuit.

But has the TCPA reduced the time and expense of litigation? Let me put it this way: I’ve given presentations on the TCPA, and when I pose this question to a roomful of lawyers, it’s sure to get big laughs.

They laugh because the last thing the TCPA has done is to reduce the amount of litigation. On the contrary, I’ve heard people call the statute a full employment act for appellate lawyers. Just look at the number of appellate decisions grappling with the TCPA.

One more anecdote will make the point plain: I recently called the court clerk in one of my cases to schedule a hearing on a motion. His first question: is this a TCPA motion?

No, the TCPA has not reduced the time and expense of litigation. And here’s a prediction. If House Bill 3300 becomes law, six months from now when you call the court clerk asking for a hearing, he’ll say in a knowing monotone, “is this a Rule 91a motion?”

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*Update: Want evidence that federal courts already have “motion to dismiss fatigue”? Check out this proposed local rule in the Southern District of Texas that would require lawyers to confer before filing a Rule 12(b)(6) motion:

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Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC.

[1] I’m paraphrasing, of course; I don’t have a transcript. And to be fair to the judge, he also grilled opposing counsel about why he included a state-court claim that seemed to be clearly preempted by federal law.

Non-Competes in the Sale of a Texas Business

If you’re buying a business in Texas and the seller agrees to a non-compete, will it hold up in court? The short answer is yes, but the non-compete should be reasonably limited to the purpose of protecting the goodwill that you are acquiring with the other assets of the business. It’s also a good idea to have the purchase agreement recite that the purchased assets include the goodwill of the business.

To understand why, let’s start with the two requirements in the Texas Covenants Not to Compete Act, affectionately known as TCNCA: (1) a non-compete must be “ancillary to an otherwise enforceable agreement” (whatever that means) and (2) a non-compete must be reasonably limited in time, geographic area, and scope of activity.

How do you make a non-compete “ancillary” to an otherwise enforceable agreement? As I explain in this short video, the most common way is to have a non-compete tied to a confidentiality agreement between an employer and an employee. This is usually sufficient to meet the “ancillary” requirement, as long as the agreement explicitly or implicitly promises to provide confidential information to the employee and the employer actually provides confidential information.

A sale of a business is different. In a typical sale, the buyer acquires the assets of the business, including goodwill. And in this information age, the goodwill is often the most valuable asset of the business.

Trouble is, you can’t just load goodwill on a truck like it’s office furniture or shop tools. Goodwill primarily consists of relationships with customers or clients, and in many cases the customer relationship is with an individual who works for the business, not so much the business itself.

A non-compete is ancillary to the sale of the goodwill because it is necessary to make the transfer effective. See, e.g., Chandler v. Mastercraft Dental Corp. of Texas Inc., 739 S.W.2d 460, 464-65 (Tex. App.–Fort Worth 1987, writ denied) (“the covenant was necessary to protect the business goodwill, the key asset”). Imagine if the seller, after selling the goodwill, could set up a new business the next day and start soliciting the sold business’s customers. Then the buyer would not really get the benefit of the transferred goodwill.

If the law refused to enforce a non-compete in this situation, it would hurt the buyer and the seller. No buyer is going to pay the full value of the goodwill without assurance that the seller cannot immediately start competing for the customers of the business. And then business owners would not be able to cash out the full value of their businesses.

So, if anything, enforcing a non-compete makes more economic sense in the sale of a business than in the employer-employee context. That explains why even California, which generally prohibits non-competes, has an exception for the sale of a business. See Cal. Bus. & Profs. Code § 16600-16602.5.

It also explains why Texas courts have said that “[a] noncompete signed by an owner selling a business is quite different than one signed by an employee.”[1] Texas courts have been more inclined to enforce long, or even limitless, time periods barring competition after a sale of a business.[2] For example, in Oliver v. Rogers, 976 S.W.2d 792, 801 (Tex. App.—Houston [1st Dist.] 1998, pet. denied), the court held that the lack of a time limitation did not render a non-compete unreasonable when it was part of the sale of a business.

But let’s not get carried away. Since 1989, all Texas non-competes are governed by the TCNCA. In addition to the “ancillary” requirement, the statute requires a non-compete to contain “limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee.” Tex. Bus. & Com. Code § 15.50(a). To the extent that any Texas case—especially a pre-1989 case—suggests that these limitations are not required in the sale of business, it should be taken with a grain of salt.

The non-compete statute does give the buyer of a business one advantage that may not be immediately obvious. In an employment agreement, the burden of proving the reasonableness of the non-compete is usually on the employer. But in the sale of a business, the burden of proof will usually be on the seller to show that the non-compete is unreasonable. See Tex. Bus. & Com. Code § 15.51(b) (placing burden of proof depending on whether the “primary purpose” of the agreement is to obligate the promisor to render “personal services”).

But again, reasonableness is still required. And here’s the slightly counter-intuitive part: if you represent the buyer in the sale of a business, you don’t want to go overboard on drafting a super-broad non-compete. In fact, it will usually be in your client’s interest to tailor the non-compete as narrowly as possible to the legitimate purpose of protecting the goodwill of the business. Anything more is too much.

What does that mean specifically?

First, you should include a reasonable time period. The time period should be no longer than necessary to protect the goodwill. Will the previous owner’s relationships with customers really have significant value four or five years later? Consider whether a two or three year period would be enough.

Second, you should include a geographic area. This will depend on the type of business, but generally a reasonable geographic area will coincide with the area where the company is doing business with its existing customers.

Third, the scope of activity restrained should be limited. This is perhaps the most neglected limitation. Remember, the purpose is to protect the goodwill of the business, which means relationships with existing customers. If the non-compete would bar the seller from competing in any way, for any customers, a judge might consider it an unenforceable “industry-wide exclusion.” The case law prohibiting industry-wide exclusions focuses on the employer-employee context, but the same concept can be applied to the sale of a business.

Ok, the seller of a business might say, but why not draft the non-compete as broadly as possible, and then if there’s a dispute you negotiate down from there?

Good question. Texas non-compete law is quite “pro-reformation,” especially in comparison to some other states. If a non-compete is unreasonably broad, that’s not the end of the story. The statute requires the trial court to reform the agreement to the extent necessary to make it reasonable. So, all is not lost if the buyer’s lawyer drafts the non-compete too broadly.

But there is a cost to be paid for making the non-compete too broad. First, if things go wrong and the seller of the business starts competing for the business’s customers, the new business owner may need to go to court to get a temporary injunction enforcing the non-compete. As a litigator who handles temporary injunction hearings, I can tell you it will be easier to make a case for a temporary injunction if the non-compete is already reasonably limited.

Second, if the non-compete is written too broadly, it effectively means that the buyer will be unable to recover damages for the seller’s breach. See Tex. Bus. & Com. Code §15.51(c). That’s a big bargaining chip to give away by making the non-compete too broad.

So if you represent the buyer, consider making the non-compete as narrow as you can while still protecting the goodwill your client is buying.

That brings up one more tip: the agreement should actually provide for the sale of the goodwill. If the purchase agreement does not expressly identify the goodwill as part of the assets being sold, there is a risk that a judge could say that the non-compete was not ancillary to an otherwise enforceable agreement.[3]

You could argue the sale of the goodwill is implied when all the other assets of the business were sold.[4] But why chance it? Unless there is a good reason not to include the goodwill (maybe a tax reason?), the safer course is to include an express recitation that the goodwill is part of the assets being sold.

____________________________________

Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Occasionally he writes a boring, useful post.

[1] Heritage Operating, L.P. v. Rhine Bros., LLC, 02-10-00474-CV, 2012 WL 2344864, at *5 (Tex. App.—Fort Worth June 21, 2012, no pet.) (mem. op.).

[2] Id. (citing cases).

[3] See, e.g., Bandera Drilling Co. v. Sledge Drilling Corp., 293 S.W.3d 867, 872-75 (Tex. App.–Eastland 2009, no pet.).

[4] The Texas Supreme Court has recognized that an agreement, such as an agreement to provide confidential information, can be implied in a non-compete. Mann Frankfort Stein & Lipp Advisors, Inc. v. Fielding, 289 S.W.3d 844 (Tex. 2009).

Can Your Business Avoid a Fraud Claim by Putting Magic Words in the Contract?

If you run a business and use contracts drafted by a lawyer, there’s a good chance you’ve seen a clause like this:

This Contract contains the complete agreement between Buyer and Seller concerning the sale of the Products and Services and replaces any prior oral or written communications between them. In entering into this Contract, Buyer is not relying on any representation made by Seller that is not stated in this Contract.

The first part is called a “Merger Clause.” The idea is that it “merges” all prior representations, understandings, and agreements into the written Contract. The second part is called a “Disclaimer of Reliance.”

The main point of the Disclaimer of Reliance is to prevent Buyer from making a fraud claim if the deal goes south. The word “fraud” sometimes intimidates non-lawyers, but the basic concept is simple: if you lie to someone in a business deal and they take action in reliance on the lie, that’s fraud.

One special flavor of fraud is “fraudulent inducement.” It sounds legalistic, but the idea is simple: if I lie to you to get you to sign a contract, that’s fraudulent inducement.

When a business deal goes bad, fraudulent inducement is a popular theory, for two reasons. First, if you prove fraudulent inducement you may be able to avoid all the self-serving terms the other guy’s lawyer put in the contract. Second, you may be able to recover actual damages and even punitive damages.

But once upon a time, a smart lawyer figured this out and put the Merger Clause and the Disclaimer of Reliance in the contract he drafted for his client. The hope was that these clauses would prevent the other party from later claiming fraudulent inducement. The idea caught on, and soon his form went viral.

So today, any time a client needs a contract, a lawyer is going to pull up some form that likely includes both a Merger Clause and a Disclaimer of Reliance. For simplicity, let’s focus on the Disclaimer of Reliance.

If a party to the contract tries to claim fraudulent inducement—either to get out of the contract or to try to get damages—the smart litigator representing the other party is going to say, “sorry, Disclaimer of Reliance.”

Not so fast. The equally smart litigator representing the party claiming fraudulent inducement has an ace up her sleeve too. The Disclaimer of Reliance is ineffective, she’s going to argue, because the entire contract—including the Disclaimer of Reliance—was induced by fraud.

Expecto patronum!

Of course, whether the seller actually lied to the buyer to induce him to sign the contract is almost always in dispute. But let’s assume for the sake of argument that the seller made material misrepresentations to the buyer that caused the buyer to sign the contract.

I know, this is Texas. Like Robert Earl Keen says, “nobody steals, nobody cheats.” But just as a hypothetical, what are courts to do with this common situation?

What Rule Should Apply to a Disclaimer of Reliance?

Let’s consider four different rules courts could choose:

A. A Disclaimer of Reliance has no effect on a fraudulent inducement claim.

B. A Disclaimer of Reliance defeats a fraudulent inducement claim.

C. A Disclaimer of Reliance is effective if, when signing the contract, the parties lit incense, struck a ceremonial gong, and recited the Latin phrase caveat emptor in unison.

D. It depends on the circumstances.

I know, choice C sounds silly, but stay with me.

Choices A through C have one clear benefit: they are what lawyers call “bright-line” rules.

Of course, there could always be a factual dispute about whether the incense was actually lit, or a legal dispute about whether the original public understanding of “gong” included a cymbal. But let’s put those quibbles aside. Choices A through C draw clear, bright legal lines that judges can apply with certainty.

But which outcome is more just? The case for Choice A is that “fraud vitiates everything.” The idea is that when one party fraudulently induces the other party to sign the contract, the whole contract is tainted. There is also a certain “realist” case to make for Choice A: the Disclaimer of Reliance is almost always standard “boilerplate” that was not specifically negotiated by the parties. So it should have no effect.

The problem with Choice A is that it tends to encourage more litigation and less certainty. Any party who regrets doing the deal can claim fraudulent inducement, even if the claim has no merit, and it can take months—or years—and thousands of dollars in legal fees to resolve that claim.

That’s why many lawyers—especially transactional lawyers—would pick Choice B: the Disclaimer of Reliance defeats the fraud claim. The rationale for B is that it may mean less justice in a handful of cases where there is real fraud, but overall it’s better for business if companies don’t have to spend time and money litigating fraud claims. Better to stick to what’s in black and white in the contract.

But there’s an obvious counter-argument to Choice B, too. If courts adopt a bright line rule that a Disclaimer of Reliance bars a fraudulent inducement claim, then everybody is going to put a Disclaimer of Reliance in their contracts (as almost everybody already does). Then you have effectively abolished the fraudulent inducement theory.

And what about Choice C, the incense ritual? No one would seriously pick Choice C, and the reason is obvious. Why should the parties’ legal rights depend on whether incense was lit and the gong was struck? Modern judicial decisions should not turn on such ritualistic formalism.

Ok, but isn’t Choice B effectively the same as Choice C? If we say that a business can avoid a fraudulent inducement claim simply by reciting the magic words “disclaimer of reliance” in the contract, is that really any different from the “gong” rule, in principle?

I think this very point—the reluctance to attach too much significance to “magic words”—is why most courts are going to pick Choice D: It depends. Courts recognize that, while a bright-line rule can provide certainty, reality is just too messy to pick one result that should apply in all cases.

That’s a less satisfying answer—especially for non-lawyers—but it’s an answer that allows courts to enforce contract terms generally, while recognizing that justice may require exceptions in some cases.

At least that’s the theory. Let’s look at a case study to see how it applies.

Big Trouble for Big Blue?

Lufkin Industries manufactures machinery and equipment for the energy industry. It needed to upgrade its business operations software, so it called a little company called International Business Machines, which I call “IBM” for short. IBM recommended its “Express Solution for SAP.”

Before the contract was signed, IBM represented to Lufkin that the Express Solution was a preconfigured system that could be implemented within four to six months and meet 80% of Lufkin’s requirements without any enhancements. Oh, and IBM knew this was false (allegedly).

Would you believe the implementation of the software system did not go well? On the day of the “go-live-ugly” (what a great term), Lufkin followed IBM’s instruction to deactivate its old system. But the IBM system didn’t work. Lufkin was unable to use the Express Solution to invoice customers, manage inventory, track orders, calculate payroll, or pay employees and vendors. In short, the system failure crippled Lufkin’s business.

A jury later found that IBM fraudulently induced Lufkin to sign the contract and awarded over $20 million in damages.

But guess what was tucked away in the IBM-Lufkin contract? That’s right, a Disclaimer of Reliance and a Merger Clause. Section 2 of the Statement of Work said:

In entering into this SOW, Lufkin Industries is not relying upon any representation made by or on behalf of IBM that is not specified in the Agreement or this SOW, including, without limitation, the actual or estimated completion date, amount of hours to provide any of the Services, charges to be paid, or the results of any of the Services to be provided under this SOW. This SOW, its Appendices, and the Agreement represent the entire agreement between the parties regarding the subject matter and replace any prior oral or written communications.

These were the facts of IBM v. Lufkin Industries, decided by the Texas Supreme on March 15, 2019.[1]

So what rule did the Texas Supreme Court apply to determine if this clause was effective?

In theory, the court applied a version of Choice D: It depends.

The court started by noting its decision in Italian Cowboy Partners that said a merger clause, standing alone, does not bar a fraudulent inducement claim. But a disclaimer of reliance, in contrast, can be effective: “a clause that clearly and unequivocally expresses the party’s intent to disclaim reliance on the specific misrepresentations at issue can preclude a fraudulent-inducement claim.”

On the other hand, “[n]ot every such disclaimer is effective,” and courts “must always examine the contract itself and the totality of the surrounding circumstances when determining if a waiver-of-reliance provision is binding.” In other words, the court must look to both extrinsic and intrinsic facts concerning the contract.

The most important fact is whether the contract was a settlement agreement that resolved a lawsuit or other dispute. Under the Schlumberger case, a disclaimer of reliance in a settlement agreement will usually be effective to bar a later fraud claim. The idea is that there has to be a way for parties to sign an agreement that ends litigation with certainty.

But most business contracts are signed at the beginning of the relationship, before any dispute. In that case, the relevant factors include whether:

(1) the terms of the contract were negotiated, rather than boilerplate, and during negotiations the parties specifically discussed the issue which has become the topic of the subsequent dispute;

(2) the complaining party was represented by counsel;

(3) the parties dealt with each other at “arm’s length”;

(4) the parties were knowledgeable in business matters; and

(5) the release language was clear.

When two businesses negotiate a contract and lawyers are involved, factors (2)-(5) will almost always apply. And in most cases the second part of (1) will be true. It’s hard to see how there could be a genuine fraudulent inducement claim if the issue in dispute was not discussed before the contract was signed.

All of those factors were present in the IBM case. With at most one factor weighing against enforcement, the court said it had “no trouble” concluding that the factors supported a finding that the disclaimer of reliance was effective. “The parties negotiated the Statement of Work at arm’s length,” the court said, “they were both knowledgeable in business matters and represented by counsel, and the two clauses expressly and clearly disclaim reliance.”

The court didn’t say much about the first half of the first factor: whether the merger clause and disclaimer of reliance were negotiated terms or mere boilerplate. I think we can assume the latter. And I think the court’s silence on that factor tells us the court doesn’t care too much about it.

So, despite the IBM opinion’s touchy-feely language about multiple factors and “totality of the surrounding circumstances,” it comes pretty close to this “bright-line” rule: when two businesses represented by lawyers negotiate a contract that contains a clear disclaimer of reliance, there is no fraudulent inducement claim, even if the disclaimer is boilerplate.

I think the “factors” and “circumstances” language is intended to give the court some wiggle room to allow a fraudulent inducement claim in a truly egregious case, e.g. where the party duped into signing the contract is an unsophisticated consumer not represented by a lawyer. But in most business cases, fraudulent inducement is out in Texas.

As long as you said the magic words.

____________________________________

Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. This post is dedicated to 80s supergroup The Power Station.

[1] Int’l Bus. Machines Corp. v. Lufkin Indus., LLC, No. 17-0666, 2019 WL 1232879, __ S.W.3d __ (Tex. Mar. 15, 2019).

"Why do you write like you're running out of time?"

Nineteen eighty nine, the number . . .

It don’t mean nothin’

Ethics Tip #1: Don’t imply an attorney-client relationship

Ethics Tip #2: Be aware of potential issue conflicts

Ethics Tip #3: Don’t say you “specialize”

Ethics Tip #4: Remember that a client’s “confidential information” includes non-confidential information

Ethics Tip #5: File your blog post if it contains “advertising”

Ethics Tip #6: Don’t compare yourself to other lawyers

The Empire SLAPPs Back

Two Wrongs Don’t Make a Right

Hearing Transcript

What Did We Learn Today?

What a Difference a Word Makes

“Frivolous” Lawsuits

The Problem of the Non-Frivolous Nuisance Lawsuit

What’s Wrong with Motions for Summary Judgment?

The Law of Unintended Consequences

What Rule Should Apply to a Disclaimer of Reliance?

Big Trouble for Big Blue?