The “Inevitable Disclosure” Doctrine in Texas Trade Secrets Litigation

Does Texas law recognize the “inevitable disclosure” doctrine? Should it?

This strikes me as the wrong question. The right question is not “should Texas follow the inevitable disclosure doctrine?” but rather “what evidence is sufficient to establish imminent harm from the threatened use of trade secrets?” I propose the following dichotomy:

In a “soft” trade secrets case, the mere fact that a former employee knows a company’s trade secrets and has gone to work for a competitor should usually be insufficient to establish the “imminent harm” necessary to support a temporary injunction barring the employee from working for the competitor. There must be something more, such as evidence of a plan to use the trade secrets, or evidence that the employee has already used or disclosed the trade secrets.
But in a “hard” trade secrets case, “something more” should not be required if the trade secret is so secret and so valuable the employee’s mere knowledge of the trade secret creates an imminent risk that the employee will disclose it to her new employer.

I admit that no. 2 is a little circular, but there’s really no getting around that. At least my test puts the emphasis on the degree of the threat, where it should be.

But what is a “soft” trade secret? Or a “hard” trade secret? And what is the inevitable disclosure doctrine in the first place? Let’s back up a bit.

The Inevitable Disclosure Doctrine

The inevitable disclosure doctrine is a concept in trade secrets law. It is the idea that a person who knows a company’s trade secrets can be enjoined from working for a competitor on the theory that the person will inevitably use that knowledge.[1] For example, in T-N-T Motorsports, Inc. v. Hennessey Motorsports, Inc.,[2] the court held that evidence that the defendants possessed the plaintiff’s confidential information and were “in a position to use it to compete” showed an “inherent threat” sufficient to support an injunction.

The Texas Uniform Trade Secrets Act (TUTSA) and the federal Defend Trade Secrets Act (DTSA) do not expressly refer to the inevitable disclosure doctrine. The doctrine can be seen as an application of the common-law “imminent harm” requirement for an injunction. The question is whether harm is imminent when a person with knowledge of the company’s trade secrets is working for a competitor.

The DTSA indirectly rejects—or at least constrains—application of the inevitable disclosure doctrine in two ways. First, it authorizes the court to grant an injunction “to prevent any actual or threatened misappropriation,” but with the important limitation that the court cannot “prevent a person from entering into an employment relationship.” The court can place conditions on such employment, provided the conditions are based on “evidence of threatened misappropriation and not merely on the information the person knows.” In other words, the court cannot limit a former employee’s work for a competitor based merely on the idea that the employee will inevitably disclose the employer’s trade secrets. Second, the injunction cannot conflict with an applicable state law “prohibiting restraints on the practice of a lawful profession, trade, or business.”[3]

Similarly, TUTSA codifies the common-law principle that an injunction may not prohibit a person from using “general knowledge, skill, and experience” acquired during employment.[4] This limitation emphasizes that injunctions should be narrowly tailored to prevent disclosure of trade secrets, not to unreasonably restrict employee mobility. Still, TUTSA at least leaves open the possibility that a risk of “inevitable disclosure” of trade secrets could establish the “imminent harm” needed to support a temporary injunction.

Texas law is unsettled on whether and to what extent the inevitable disclosure doctrine applies.[5] But we can draw some preliminary conclusions from the case law.

First, if there is evidence that the employee has already disclosed the alleged trade secrets to the competitor, or used the alleged trade secrets while working for the competitor, then resort to the inevitable disclosure doctrine is unnecessary. The doctrine really only becomes a real issue when the evidence is that the employee possesses or knows the trade secrets but has not done anything wrong with them—yet.

Second, inevitable disclosure really goes to the question of an injunction, not damages.

Global Supply v. Riverwood

Both principles were apparent in Global Supply Chain Solutions, LLC v. Riverwood Solutions, Inc., No. 05-18-00188-CV, 2019 WL 3852661 (Tex. App.—Dallas Aug. 16, 2019, no pet. h.), a recent case showing the limits of the “inevitable disclosure” argument.

In that case, Global Supply and Riverwood were competitors in the supply chain management industry, including product data management (PDM) services. Id. at *1. They had merger discussions in which Global Supply provided a seven-page PowerPoint presentation containing financial information about Global Supply. Id. at *2. After these discussions were abandoned, Riverwood unsuccessfully solicited two customers of Global Supply and recruited Lori Austin, a consultant for Global Supply, to be Riverwood’s director of PDM services. Id. at *2-3.

Global Supply sued Riverwood and Austin in Collin County District Court, claiming misappropriation of trade secrets, but Global Supply never set a hearing on a temporary injunction. Id. at *4. After some discovery and designation of experts, the parties filed motions for summary judgment, including Riverwood’s motion for summary judgment on Global Supply’s trade secrets claim. Id.

The problem for Global Supply was that there was no “direct evidence” that Austin disclosed any trade secret to Riverwood. Id. at *7. So Global Supply argued that it was “inevitable” that Austin would disclose its trade secrets in the course of her employment at Riverwood. Id. In other words, the inevitable disclosure doctrine.

In support of its argument, Global Supply cited the Seventh Circuit’s statement that “a plaintiff may prove a claim of trade secret misappropriation by demonstrating that defendant’s new employment will inevitably lead him to rely on the plaintiff’s trade secrets.” Id. (citing PepsiCo, Inc. v. Redmond, 54 F.3d 1262, 1269 (7th Cir. 1995)).

But Collin County ain’t in the Seventh Circuit, and the trial court granted summary judgment for Riverwood and Austin.

The Dallas Court of Appeals affirmed, rejecting Global Supply’s inevitable disclosure argument. The court cited Cardinal Health Staffing Network, Inc. v. Bowen, 106 S.W.3d 230, 241-42 (Tex. App.—Houston [1st Dist.] April 3, 2003, no pet.), which said “[w]e have found no Texas case expressly adopting the inevitable disclosure doctrine, and it is unclear to what extent Texas courts might adopt it or might view it as relieving an injunction applicant of showing irreparable injury.” Id.

Global Supply argued that the adoption of TUTSA brought the inevitable disclosure doctrine to Texas, but the court disagreed. The court reasoned that the “ultimate merits” are not at issue in a temporary injunction hearing in a trade secret misappropriation case. Thus, whatever merit the inevitable disclosure argument may have in support of a temporary injunction, the court said the argument is insufficient to raise a fact issue on damages in response to a motion for summary judgment. Id. at *8.

The court then turned to whether Global Supply had offered sufficient evidence on the elements of its TUTSA claim. Global Supply offered the following:

The idea that building supply sourcing could be operated as a standalone business was the trade secret misappropriated by Riverwood.
Riverwood contacted a Global Supply customer about using Riverwood for sourcing building supplies, knowing he was a Global Supply customer.
Austin was doing the same work at Riverwood that she did for Global Supply.
Peck, Global Supply’s president, testified that Austin “must have” disclosed Global Supply’s confidential information in order to do her job at Riverwood.
Peck also testified that building supply sourcing “was unlike anything Riverwood was doing at the time.”

Id. at *14-15.

So, the evidence of misappropriation was pretty thin, especially in light of controverting evidence:

Global Supply did not share any information about its building supply sourcing business model with Riverwood.
The seven-slide PowerPoint presentation did not include this information, and Global Supply conceded that the merger discussions did not involve delivery of trade secrets other than that delivered in writing.
Riverwood had sourced building supplies before the merger discussions.
Peck conceded Riverwood could have provided building supply sourcing without his being aware of it.
Global Supply did not lose any business from the customer Riverwood contacted.
Austin testified she returned all company property to Global Supply, did not retain Global Supply documents, complied with her confidentiality agreement, never disclosed Global Supply’s confidential information or trade secrets to Riverwood, and only used generally known information.
Peck conceded he had no knowledge of the work Austin was actually doing at Riverwood.
Austin testified about how she performed her job responsibilities at Riverwood without using Global Supply’s confidential information.

Id. at *14-15.

Based on the evidence, the Court of Appeals held that the trial court properly granted summary judgment against Global Supply’s trade secrets claim. Id. at *15-16. Thus, the “inevitable disclosure” argument could not fill the gaps in Global Supply’s evidence of misappropriation of trade secrets.

So did Global Supply reject the inevitable disclosure doctrine? Not really. Two significant factors limit the reach of Global Supply. First, it was not a temporary injunction case. Trying to use the inevitable disclosure doctrine as a substitute for direct evidence of damages was a stretch.

Second, the court seemed skeptical of Global Supply’s theory that its business model was a trade secret in the first place. This was apparent in the court’s statement that “Global supply does not point to any summary judgment evidence that it shared with Riverwood any information about its ‘business model’ that ‘took extensive effort to develop.’” Id. at *15.

A Harder Case

Imagine instead a temporary injunction case with evidence that the alleged trade secret is really secret and really valuable. Let’s say an oilfield services company develops a secret drilling technology that a competitor would pay millions for. The engineer who developed the technology for the company gets hired by a direct competitor as Director of Engineering. There’s no evidence that the engineer has disclosed the technology to the competitor, or even evidence that he plans to do so, but the trial court enters a temporary injunction barring the engineer from working for the competitor, citing the imminent risk that the engineer will disclose the technology.

That’s a stronger case for application of the inevitable disclosure doctrine, first because it involves an injunction and second because it involves a “hard” trade secret.

The two quintessential types of hard trade secrets are “secret sauce,” like the Colonel’s herbs and spices or the formula for Coke, and secret cutting-edge technology, like say, laser guidance for self-driving cars. When an employee runs off to a competitor with that kind of secret, it does seem a little unfair to require proof that employee has already given the secret to the competitor.

“Soft” trade secrets are different. Soft trade secrets are things like customer lists, customer information, and pricing information. Virtually every business has this kind of information. That doesn’t mean the information can’t be a trade secret. It can, as I explained in When Is a Customer List a Trade Secret?

But there’s a danger here. If courts grant injunctions too freely in soft trade secret cases, they risk turning trade secret law into a “de facto” non-compete for all employees who have customer information. And Texas courts have recognized we don’t want to do that. See Trilogy Software, Inc. v. Callidus Software, Inc., 143 S.W.3d 452, 466-67 (Tex. App.—Austin 2004, pet. denied) (“this does not mean that trade secret status automatically attaches to any information that a company acquires regarding its customers; if it did, it would amount to a de facto common law non-compete prohibition”).

That’s why I say in a soft trade secrets case, there should be some evidence that the employee has used or disclosed the trade secrets—or plans to do so—before the court grants a temporary injunction. If Texas courts are going to embrace the notion of “inevitable disclosure” at all, it should be limited to cases involving hard trade secrets.

Of course, the distinction between hard and soft trade secrets is not in the statutes; it’s just my terminology. And you could always have borderline cases (“semi-soft” trade secrets?) But the underlying concept—that the degree of secrecy and value of the alleged trade secrets is a factor in determining whether a temporary injunction should be granted—is sound. At least it focuses on the right question.

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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. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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.

[1] See The Inevitable Disclosure Doctrine: A Necessary and Precise Tool for Trade Secret Law.

[2] 965 S.W.2d 18, 24 (Tex. App.—Houston [1st Dist.] 1998, pet. dism’d).

[3] 18 U.S.C. § 1836(b)(3).

[4] Tex. Civ. Prac. & Rem. Code § 134A.003.

[5] Cardinal Health Staffing Network, Inc. v. Bowen, 106 S.W.3d 230, 241-42 (Tex. App.—Houston [1st Dist.] April 3, 2003, no pet.); DGM Services, Inc. v. Figueroa, No. 01-16-00186-CV, 2016 WL 7473947, at *5 (Tex. App.—Houston [1st Dist.] Dec. 29, 2016, no pet.) (mem. op.).

Burning Down the Haass: The Industry-Wide Exclusion Rule in Texas Non-Compete Law

WARNING: This week’s post is heavy on case law. Non-lawyers should turn back immediately. You might like one of my lighter posts about Seinfeld, my Morning Routine, or Choice of Law in Texas Non-Compete Litigation.

If you know anything about Texas non-compete law, you know that the Texas non-compete statute requires reasonable limitations as to “time, geographical area, and scope of activity to be restrained.” Tex. Bus. & Com. Code § 15.50(a).

Yet in my practice, I often see non-competes drafted without a reasonable limit on the scope of activity restrained. Scope of activity is probably the most neglected element of Texas non-compete law. Often, the non-compete will bar an employee from having anything to do with any company in the employer’s industry.

When you read one of these, you can almost feel the drafter’s pride in writing a non-compete that is so comprehensive and ensnaring. But guess what? Writing it that way makes it an “industry-wide exclusion,” which Texas courts have said is unenforceable.

The industry-wide exclusion rule has two halves (plus a corollary I’ll get to later).

The first half says that a non-compete that prevents a company’s employee from working in any capacity in the company’s industry is unreasonably broad and therefore unenforceable.

The second half says that a non-compete must be limited to preventing the employee from doing business with customers the employee had dealings with while working for the employer.

The second half of the rule is found in Peat Marwick Main & Co. v. Haass, 818 S.W.2d 381 (Tex. 1991), which arose from a suit that was already being litigated when the 1989 statute was adopted.

In Haass the Texas Supreme Court cited the Texas common-law rule that the scope of a non-compete must not be greater than necessary to protect the employer’s legitimate interests such as goodwill and confidential information. Id. at 386. The court reasoned that the “fundamental legitimate business interest” protected by a non-compete is “preventing employees or departing partners from using the business contacts and rapport established during the relationship . . . to take the firm’s customers with him.” Id. The court also approvingly cited a Wisconsin case stating that “the restrictive covenant must bear some relation to the activities of the employee.” Id. at 387.

I love that Haass uses the French rapport instead of the Anglo-Saxon “goodwill.” It was a more civilized time.

Anyway, the Haass court held that the non-compete was overbroad because it inhibited departing partners from providing accounting services to clients acquired after the partner left, or with whom the accountant had no contact while associated with the firm, which was not reasonably necessary to protect the firm’s goodwill. Id. at 388.

Haass did not use the term “industry-wide exclusion,” but the Fourteenth Court of Appeals later cited Haass for the proposition that “[t]he Texas Supreme Court has held that an industry-wide exclusion is unreasonable.” John R. Ray & Sons, Inc. v. Stroman, 923 S.W.2d 80, 85 (Tex. App.—Houston [14th Dist.] 1996, writ denied) “In the case of covenants applied to a personal services occupation, such as that of a salesman,” the court said, “a restraint on client solicitation is overbroad and unreasonable when it extends to clients with whom the employee had no dealings during his employment.” Id.

Applying both parts of the rule, the Stroman court held that the non-compete was unenforceable because it imposed an industry-wide exclusion on the employee’s ability to work in the insurance business in and around Harris County and extended to customers the employee had no association with while working for the employer. Id.

The First Court of Appeals applied Haass and Stroman to the oilfield services industry in Brown Services, Inc. v. Brown, No. 01-98-00304-CV, 1999 WL 681964 (Tex. App.—Houston [1st Dist.] Sept. 2, 1999, pet. denied) (mem. op.). Rapport is important in oilfield services, because everybody knows who the customers are.

Brown Services held that a first clause barring the employee from being connected to any oilfield services business was an overbroad industry-wide exclusion. Id. at *6. The court held that a second clause barring the employee from soliciting or selling products or services to anyone who was a customer of the employer during his employment was overbroad, because it was not limited to customers he had contact with. Id. at *7. So you see both halves of the rule.

Same for Wright v. Sport Supply Group, Inc., 137 S.W.3d 289, 298 (Tex. App.—Beaumont 2004, no pet.), where the court cited Haas and Stroman for the propositions that “[a] covenant not to compete that contains an industry-wide exclusion from subsequent employment is unenforceable,” and “a covenant not to compete that extends to clients with whom a salesman had no dealings during his employment is unenforceable.” The court held that the agreement at issue was overbroad and unenforceable because it was not limited to customers the employee had dealings with while employed by the company. Id.

Wright also cited Haass for the principle that “[a] restrictive covenant is unreasonable unless it bears some relation to the activities of the employee.” Id. You might call this the “janitor corollary” of the industry-wide exclusion rule. The idea is that a non-compete that would bar a salesman from working for a competitor as a janitor would be unreasonably broad.

Four years later, the Beaumont Court of Appeals considered whether the Texas Supreme Court’s intervening decision in Sheshunoff changed the industry-wide exclusion rule applied in Wright. See Pool v. U.S. Money Reserve, Inc., No. 09-08-137 CV, 2008 WL 4735602, at *8 (Tex. App.—Beaumont 2008, no pet.) (mem. op.) (addressing Alex Sheshunoff Mgmt. Servs., L.P. v. Johnson, 209 S.W.3d 644 (Tex. 2006)).

The Poole court said that Sheshunoff was distinguishable because it involved a non-compete that only prevented the employee from soliciting prior clients with whom he had personal contact or any previously identified prospective client. Thus, the court reasoned, Sheshunoff did not change the industry-wide exclusion rule. Id. at *8.

(Sheshunoff was the case that cleared up confusion about whether a non-compete is “ancillary to an otherwise enforceable agreement,” an issue I explain in convenient video form here.)

In another post-Sheshunoff case, CDX Holdings, Inc. v. Heddon, No. 3:12-CV-126-N, 2012 WL 11019355, at *10 (N.D. Tex. March 2, 2012), the court held that the scope of activity restrained was overbroad, where the non-compete applied to all anatomic pathology work performed by the employer, even though the employee’s work exclusively involved dermatopathology.

Obviously, dermatopathology is narrower than anatomic pathology. Duh.

The janitor corollary appeared again in Weber Aircraft, L.L.C. v. Krishnamurthy, No. 4:12-CV-666, 2014 WL 12521297 (E.D. Tex. Jan. 27, 2014). In that case the non-compete barred the employees from working for a company providing the same products (seating products and components) as the employer or working for five specific competitors in any capacity. Citing Wright, the court held that a restriction barring the employees from working for five competitors, “even in a position that would not require [the employees] to use any of [the employer’s] confidential information, such as a janitor position,” was unreasonably broad. Id. at *8.

cruise-ship-615116_1280 — D’Onofrio applied the industry-wide exclusion rule to the travel industry

More recently, the Fifth Circuit weighed in on the industry-wide exclusion rule in D’Onofrio v. Vacation Publications, Inc., 888 F.3d 197, 211-12 (5th Cir. 2018), where it applied Haass and Stroman to a non-compete involving the travel industry. The court held that the non-compete as written was unenforceable because the covenants “amount to an industry-wide restriction—preventing former employees from working in any job related to the sales or marketing of not just cruises, but also a host of other travel products—and are not limited as to either geography or clients with whom former employees actually worked during their employment.” Id. at 212.

Thus, the industry-wide exclusion rule appears to be alive and well in Texas today—in several forms. But the rule has its limits.

1. When the non-compete does not prohibit working in the industry

Of course, a non-compete that is limited to customers the employee did business with does not run afoul of the industry-wide exclusion rule. In Gallagher Healthcare Insurance Services v. Vogelsang, 312 S.W.3d 640 (Tex. App.—Houston [1st Dist.] 2009, pet. denied), the court approvingly cited the industry-wide exclusion rule of Haas and Stroman, id. at 654, but the court held that the non-compete at issue did not violate the rule, because “[u]nlike some covenants not to compete that preclude the employee from working in the same industry, the agreement here does not limit [the employee] from working in the insurance business.” Id. at 655.

Similarly, in Stone v. Griffin Commc’ns & Security Sys., Inc., 53 S.W.3d 687, 694 (Tex. App.—Tyler 2001, no writ), the court held that a non-solicitation clause limited to customers the employees had contact with while employed by the employer was not an impermissible industry-wide exclusion.

2. When the “industry” is broader than the company’s niche

What exactly is the “industry” for purposes of the industry-wide exclusion rule? In M-I LLC v. Stelly, 733 F.Supp.2d 759, 794 (S.D. Tex. 2010), the non-compete applied to any customer or potential customer of the employer in the business of oilfield displacement tools or services. The employee argued this was an impermissible industry-wide exclusion. Id. The employer argued the non-compete only applied to well completion services, not the oil and gas industry generally, and therefore was not an “industry-wide” ban. Id. at 796.

pump-jack-848300_1920 — Texas courts have applied the industry-wide exclusion rule to oilfield services

The court sided with the employer. The court distinguished Stroman as involving a bar on the insurance business generally, while the non-compete in Stelly did not apply to the entire oil and gas industry. Id. at 796. Considering the “industry” to be oil and gas, not the “niche” services offered by the employer, the court held that the non-compete did not impose an impermissible industry-wide exclusion, but instead limited its scope to a reasonably narrow business area that correlated to the employee’s work for the company. Id. at 797.

In Salas v. Chris Christensen Systems, Inc., No. 10-11-00107-CV, 2011 WL 4089999, at *20 (Tex. App.—Waco Sept. 14, 2011, no pet.) (mem. op.), the court held that a non-compete that applied to the “pet supply manufacturing and distribution industry” did not apply to “the entire industry pertaining to pets or pet products,” where the employee was free to return to his previous work as a dog handler and groomer.

Similarly, in Merritt Hawkins & Assocs., LLC v. Gresham, 79 F.Supp.3d 625, 641 (N.D. Tex. 2015), the court held that a non-compete applying to permanent and temporary medical staffing was not an industry-wide exclusion, where it did not prohibit the employee from working in “other sections of the staffing industry or the medical industry.”

3. When the evidence does not show the restriction amounts to an industry-wide exclusion

The industry-wide exclusion rule may not apply if the employee fails to offer evidence that a prohibition of being associated with any “competitor” of the company amounts to an industry-wide exclusion.

In Republic Services, Inc. v. Rodriguez, No. 14-12-01054-CV, 2014 WL 2936172 (Tex. App.—Houston [14th Dist.] 2014, no pet.) (mem. op.), the court held that Stroman did not apply absent evidence that the “competitor” scope of the non-compete was “tantamount to an industry-wide prohibition.” Id. at *8. The employee offered no evidence about the industry at issue, the court said, and the employer offered evidence that there were companies in the legal services or legal support services industry that were not competitors of the employer. “On this record, we cannot determine as a matter of law that the covenant imposed an unreasonable industry-wide exclusion.” Id.

“On this record” is a signal courts use to emphasize that the result could be different in a case with different facts.

For example, in McKissock, LLC v. Martin, 267 F.Supp.3d 841, 855-56 (W.D. Tex. 2016), a non-compete barring the employee from being “connected in any manner with any business or practice which is in competition with [employer]” was overbroad as written.

4. When the employer’s interest is not just its goodwill, but also protecting confidential information

The industry-wide exclusion rule as stated in Haas and Stroman is incomplete because it does not address confidential information. Limiting the non-compete to customers the employee had dealings with may not be required when there is a danger of the employee using knowledge of the company’s confidential information to compete for other customers.

For example, in Accruent v. Short, 1:17-CV-858-RP, 2018 WL 297614, at *1 (W.D. Tex. Jan. 4, 2018), the employee served as a director of client services and a senior engineer for a software services company and had access to a wide range of confidential proprietary information. The non-compete prohibited competing with the portions of the employer’s business in which the employee actively participated or received confidential company information. Id.

The employee in Accruent argued that the non-compete violated the Haass rule because it was not limited to customers and prospects the employee worked with at the company, but the court did not read Haass so broadly. Id. at *5. The court said that Haass applies more narrowly to cases where the employer’s interest “derives from the employee’s relationship with his or her clients.” Id.

In Accruent, the court explained, the employee’s role gave him access to confidential proprietary information concerning the company’s product functionality, development plans, sales pipeline, sales process, customer preferences, and market research. Thus, the concern animating the non-compete was not just that the employee would “use his rapport with his customers to take them with him to a competitor,” but principally the concern that the employee would use the confidential information he learned at the company to help another company compete. Thus, the court found that Haass did not compel finding the non-compete’s scope unreasonable. Id. at *6.

code-1076536_1920 — Accruent v. Short applied the Haas rule more narrowly where a software company’s confidential information was at stake

But there was another problem with the non-compete in Accruent. Recall the janitor corollary from Haass and Wright, i.e. the principle that a non-compete must bear some relation to the activities of the employee. The non-compete in Accruent arguably prohibited the employee for working for a competitor regardless of his role, i.e. even if he was “emptying trash cans” for a competitor. The court agreed that a non-compete barring an employee for working for a competitor in any capacity is invalid. To address this defect, the court reformed the non-compete such that it would only prohibit the employee from working for a competitor in the same or substantially similar role that he performed for his previous employer. Id. at *6-7.

5. When the restriction applies to solicitation of employees, not customers

The industry-wide exclusion rule may not apply to solicitation of employees, as opposed to customers. In Smith v. Nerium Int’l, LLC, No. 05-18-00617-CV, 2019 WL 3543583, at *8-9 (Tex. App.—Dallas Aug. 5, 2019, no pet. h.) (mem. op.), the court held that the industry-wide exclusion rule did not apply to a clause barring a former employee from soliciting the company’s other employees, reasoning that the clause did not bar the former employee from working for the company’s competitors. Id. at *9.

PRACTICE TIPS

The cases above suggest some tips for practitioners:

1. Don’t draft your non-compete with an industry-wide exclusion. That should be obvious by now, but you’d be surprised how many non-competes still have this.

2. When drafting the non-compete, consider limiting it to customers the employee had contact with while employed by the company. Alternatively, you can also include customers that the employee received confidential information about. (Check out my Plain-Language Non-Compete for some ideas.)

3. The practice tip suggested by Republic Services is that if the non-compete is not an industry-wide exclusion on its face, the employee should offer evidence that the scope of the non-compete would effectively prevent the employee from working in any capacity in the industry at issue.

4. Finally, remember that determining whether a Texas non-compete is enforceable as written is just the first step. Even if the scope violates the industry-wide exclusion rule, the court can enter a temporary injunction that enforces the non-compete in part, or reform the non-compete to make the scope reasonable. For more on the practical results of Texas non-compete law, see Wolfe’s First Law of Texas Non-Compete Litigation.

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Oh Lord, Won’t You Buy Me a Mercedes-Benz Dealership?

The scene: Cameron County Courthouse, Brownsville, Texas. Plaintiff’s closing argument in Carduco, Inc. v. Mercedes-Benz USA.

Ladies and gentlemen of the jury, there was a time when a handshake and a man’s word meant something here in the Rio Grande valley. If you made a deal and shook on it, you could take that to the bank.

My client Renato Carduco grew up in that era. He built his successful car dealerships on principles of honesty and hard work. If he told a customer he was going to do something, he did it. If he promised his employees something, he kept the promise. And he expected other people to keep their word too.

He certainly expected that when he made a deal with Mercedes-Benz USA. You heard the testimony. When Mr. Carduco’s son was having trouble with his Mercedes dealership in Harlingen, Mr. Carduco agreed to buy it. But he knew Harlingen wasn’t the best place for it, so he wanted the option to move the dealership to McAllen.

So Mr. Carduco did what any experienced businessman would do. He asked Mr. Oswald, the Mercedes representative, if it would be possible to move the dealership, and Mr. Oswald said “that won’t be a problem, we don’t have any other plans for McAllen.” So Mr. Carduco went into the deal believing he would have the option to move.

But then when Mr. Carduco saw the proposed contract, something was wrong. You may remember Plaintiff’s Exhibit 9, the Purchase Agreement. It had this part saying that Mr. Carduco was, and I quote, “only purchasing the right to conduct a Mercedes-Benz retail sales dealership at Purchaser’s present location in Harlingen, Cameron County, Texas.” And it prohibited Mr. Carduco from changing locations without written consent from Mercedes-Benz USA.

Well that was a red flag for Mr. Carduco. So he called up Mr. Oswald and said, “Frank, I’m concerned about this part of the contract that says I’m only getting the right to have a dealership in Harlingen, what if I want to move it to McAllen?” And you remember what Mr. Oswald said. “Renato, don’t worry about that stuff in the contract, if you decide to move, we’ll take care of you.”

Trouble is, Mr. Oswald didn’t tell Mr. Carduco the whole story. You heard the testimony and saw the emails. At the same time, Mercedes-Benz USA was talking to another Mercedes dealer about building a new dealership in McAllen. But they didn’t disclose that to Mr. Carduco until after he had signed the contract.

So, when Mr. Carduco signed that Purchase Agreement, he believed two things. One, that there were no plans for some other dealer to set up shop in McAllen, and two, that he could relocate his dealership to McAllen if he wanted to.

Ladies and gentlemen, that’s fraud. So I hope that after you consider the evidence, you will write “Yes” in response to Question No. 1.

The Real Case

If you like to keep up with recent Texas Supreme Court opinions—and who doesn’t?—you know this hypothetical closing argument is based on a real case, Mercedes-Benz USA, LLC v. Carduco, Inc. (Tex. Feb. 22, 2019). The jury in that case answered “yes” Mercedes-Benz committed fraud, and found actual damages of $15.3 million and punitive damages of over $100 million.

Let’s pause right there. A jury in the Valley enters a $100 million verdict for a local businessman against a big multinational corporation. Already, you know that verdict is not likely to survive a trip to the Texas Supreme Court.

auto-3095196_1920 — My friends all have Porsche dealerships . . .

And yes, the Texas Supreme Court later threw out the verdict, holding there was no evidence of fraud. The court said Carduco could not have justifiably relied on alleged statements by Mercedes-Benz USA that the written contract directly contradicted.

But what about the facts in bold in the closing argument above? Mercedes-Benz specifically told Carduco he could move and not to worry about what the contract said. How is that not fraud?

Well, here’s the thing. I made up those facts (the ones in bold). I made them up to make the case harder. To me, the key question raised by Mercedes-Benz is whether those additional facts would have made a difference to the outcome.

Let me explain.

Texas Law on Fraud, Omissions, and Justifiable Reliance

First let’s put the Mercedes-Benz case in context by laying out some basic principles of fraud law:

Fraudulent inducement is a type of fraud. It’s the claim that one party fraudulently induced another party to sign a contract. It allows the defrauded party to avoid the obligations of the contract and, potentially, to recover damages caused by the fraud.
The most basic element of fraud is a misrepresentation. There has to be a material misrepresentation made with some kind of intent. (Let’s set aside the intent and materiality elements for now.)
An affirmative misrepresentation is easy. If you make a statement that is not true, that’s a misrepresentation.
Omissions are harder. Generally, an omission is not fraud, unless there is a duty to disclose.
If one of the parties owes a fiduciary duty to the other, there would be a duty to disclose. But in most “arms-length” transactions between two businesses, there is no fiduciary duty relationship and no general duty to disclose.
A duty to disclose can arise if you make a representation that, while technically true, is rendered misleading by your omission.
The next most basic element of fraud is reliance. The person you make the representation to must decide to sign the contract in reliance on the representation.
It has to be a certain kind of reliance. Some courts say “reasonable” reliance. Recent Texas cases use “justifiable” reliance. In any case, unreasonable reliance is not going to be justifiable reliance.
There is often conflicting evidence regarding whether the alleged misrepresentation is made. But as long as there’s at least a smidgen of evidence, most appellate court decisions addressing fraud will assume the misrepresentation was made.

As you can gather from this summary, there are a lot of “general” rules and a lot of exceptions. But this outline will hold true most of the time.

Here’s where it gets more difficult: the contract. In almost any business transaction, there will be a written contract that contains statements that conflict with the claim of fraud. That’s because the lawyer who drafted the contract (or the form the contract is based on) wanted to avoid claims of fraud.

The most common contractual terms that conflict with a claim of fraud are:

A merger clause, e.g. “This Agreement replaces and supersedes all prior agreements and understandings between the parties regarding the subject matter of this Agreement.”
A disclaimer of reliance, e.g. “No party to this Agreement is relying on a representation or agreement not contained within the four corners of this Agreement.”
A specific substantive contract term that conflicts with the alleged misrepresentation. For example, a clause that says “you cannot move your dealership” when the alleged misrepresentation is “we will let you move your dealership.”

What is the effect of such terms? Do they defeat a subsequent claim of fraudulent inducement?

There is no easy answer. Texas courts—like courts everywhere in the Anglo-American common-law tradition—have struggled with this question for decades, if not centuries. (Courts in other traditions probably struggle with it too, but I have no familiarity with that.)

There are three basic alternatives courts have to choose from:

The contractual terms defeat any conflicting claim of fraudulent inducement.
The contractual terms have no effect on a claim of fraudulent inducement.
It depends on the circumstances.

You can make a reasonable case for each of these, but no. 3 is the most common. Even when courts appear to endorse no. 1 or no. 2, they are probably following no. 3, because they would rule differently if presented with different facts.

The Texas Trend

Texas courts generally follow no. 3, but the pronounced trend in the Texas Supreme Court in the last 30 years has been towards holding that contractual terms negate a claim of fraudulent inducement.

The traditional rule is that “fraud vitiates a contract.” For example, in Dallas Farm Machinery Co. v. Reaves, 307 S.W.2d 233, 239 (Tex. 1957), the court held that a merger clause does not bar a claim that the contract was induced by fraud. Part of the rationale is that you shouldn’t enforce a contractual disclaimer when the disclaimer itself—as part of the contract—was induced by fraud.

The Texas Supreme Court reaffirmed the traditional principle in Williams v. Glash, 789 S.W.2d 261 (Tex. 1990). Writing for the majority, Justice Doggett said “a release is a contract and is subject to avoidance, on grounds such as fraud or mistake, just like any other contract.” Id. at 264.

But in the 1990s the Texas Supreme Court started whittling away the traditional rule. This trend coincided with complete Republican control of the court. This is not surprising, because generally conservatives favor enforcing contractual disclaimers, while liberals favor letting fraud verdicts stand. I’m generalizing, of course, but let’s not ignore the elephant in the room.

The trend began with Prudential Ins. Co. v. Jefferson Associates, Ltd., 896 S.W.2d 156, 161-62 (Tex. 1995), where the court held that an “as is” clause in a real estate purchase contract conclusively negated the reliance element of a fraudulent inducement claim.

Then in Schlumberger Technology Corp. v. Swanson, 959 S.W.2d 171, 180-81 (Tex. 1997), the court held that a disclaimer of reliance negated a claim of fraudulent inducement, where the release at issue was intended to resolve a dispute, it was an “arms-length” transaction, the parties had highly competent legal counsel, and the parties were “knowledgeable and sophisticated business players.”

After that, defense counsel in any fraud case with a disclaimer of reliance would rely heavily on Schlumberger. And in Forest Oil Corp. v. McAllen, 268 S.W.3d 51, 58 (Tex. 2008), the court extended Schlumberger to a settlement agreement intended to resolve past and future claims.

The Texas Supreme Court slightly bucked the trend in Italian Cowboy Partners, Ltd. v. Prudential Ins. Co. of Am., 341 S.W.3d 323 (Tex. 2011). The contract in that case had a merger clause, but not a disclaimer of reliance. The court distinguished a mere merger clause from a disclaimer of reliance and held that the merger clause did not negate a claim of fraudulent inducement. Id. at 336.

But the court returned to form in JPMorgan Chase Bank, N.A. v. Orca Assets G.P., L.L.C., 546 S.W.3d 648 (Tex. 2018). This time the issue was not so much the effectiveness of the contractual disclaimer, but the justifiable reliance element of the fraud claim. The court held that an experienced oil and gas business could not justifiably rely on a lessor’s statement that certain acreage was “open,” i.e. not already leased, where the contract contained an unusual negation-of-warranty clause and there were other “red flags” indicating that maybe the acreage was already leased. Id. at 660.

The court in Orca Assets approvingly cited case law holding that in an arms-length transaction, the defrauded party must exercise “ordinary care for the protection of his own interests” and “cannot blindly rely on a representation by a defendant where the plaintiff’s knowledge, experience, and background warrant investigation into any representations before the plaintiff acts in reliance upon those representations.” Id. at 654.

In February 2019, the court addressed justifiable reliance again in Mercedes- Benz (more about that later).

Then the Texas Supreme Court returned to disclaimers of reliance in IBM Corp. v. Lufkin Industries, LLC (Tex. March 15, 2019). In contrast to Schlumberger, Lufkin Industries addressed a contract signed at the beginning of the business relationship, not an agreement to resolve a dispute. But the court held that the customer’s fraudulent inducement claim against IBM was barred, where the parties were sophisticated, both sides had lawyers, and two contract clauses expressly and clearly disclaimed reliance. I wrote about this case in Can Your Business Avoid a Fraud Claim by Putting Magic Words in the Contract?

Most recently, it was justifiable reliance again in Barrow-Shaver Resources Co. v. Carrizo Oil & Gas, Inc. (Tex. June 28, 2019). The court held that a driller could not have justifiably relied on a production company’s oral statement that the company would not unreasonably withhold consent for the driller to assign its interest in a “farmout” agreement.

truck-3354501_1920 — Truckin’ . . . got the ways and means

As these cases illustrate, the Texas Supreme Court has used both contractual disclaimers and the justifiable reliance element to steadily carve back the fraudulent inducement theory in business transactions.

Back to Mercedes-Benz

Mercedes-Benz was part of this trend. It held that Mr. Carduco’s reliance on the alleged misrepresentation about the dealership was not justifiable, where Mr. Carduco was a sophisticated businessman, both sides had lawyers in the transaction, and the alleged misrepresentation directly conflicted with specific statements in the contract. The court also held that, even crediting Mr. Carduco’s testimony, there was no evidence that Mercedes-Benz made any affirmative misrepresentation to Mr. Carduco.

The part of Mercedes-Benz I don’t fully grasp is why it was necessary to reach the issue of justifiable reliance in the first place. Why didn’t the court just say there was no evidence of a misrepresentation and stop there? The court seemed awfully eager to write about justifiable reliance.

In any case, the result in Mercedes-Benz is not surprising. The plaintiff’s most fundamental problem was the absence of a clear, affirmative misrepresentation.

But what if the facts had been better for Mr. Carduco? What if, as hypothesized in my fictional closing argument above, the Mercedes-Benz representative had specifically told Mr. Carduco something like “don’t worry about what the contract says, we’ll let you move to another location”?

You could argue that the same reasoning in the Mercedes-Benz opinion would still apply and it wouldn’t make a difference. The rationale of Mercedes-Benz was that a sophisticated business can’t justifiably rely on a representation that is directly counter to what the contract says.

And you could cite the Texas Supreme Court’s subsequent decision in Barrow-Shaver. In that case the sophisticated and experienced parties deleted “shall not be unreasonably withheld” language from a consent-to-assign clause in the contract; thus the provision was “specifically negotiated through a back-and-forth process.” Under those circumstances, the court held that the plaintiff could not justifiably rely on the defendant’s oral promises that “it won’t be a problem,” “don’t worry about,” and “we will work with you.”

On the other hand, in Mercedes-Benz there was no back-and-forth negotiation of the term requiring consent to move the dealership. And under my hypothetical facts, you could make a case that Mr. Carduco’s reliance would have been more justifiable. It’s one thing to say that an experienced business person should not rely on his own vague “belief” that he is going to be allowed to do something the contract says he cannot do. It’s quite another to say he can’t rely on a man’s word.

________________________

Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who focuses on non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

Shrinkage: TX Legislature and 5th Circuit Cut the TCPA Down to Size

We had a good run, me and the TCPA.

But this may be my last post about the statute that fundamentally changed Texas litigation for a short, but exhilarating, time. The reasons will become apparent.

This is my tenth and possibly last blog post on the Texas Citizens Participation Act. My loyal Fivers will remember these great party jams:

A SLAPP in the Face to Texas Trade Secrets Lawsuits – Part 1 (5/30/17)

A SLAPP in the Face to Texas Trade Secrets Lawsuits – Part 2 (6/12/17)

A SLAPP in the Face to Texas Trade Secrets Lawsuits, or Much Ado About Nothing? (7/3/17)

It’s Alive, It’s ALIVE! How to Kill a TCPA Motion in a Trade Secrets Lawsuit (11/12/18)

Houston Judge Calls Out Texas Supreme Court’s Simplistic “Textualist” Approach to TCPA (1/7/19)

Can You “Plead Around” the TCPA? (2/11/19)

Legislation Aims to Reign in the TCPA, Protect Non-Compete Suits (3/4/19)

Metroplex Courts Push Back on Broad Application of TCPA (3/18/19)

Turn Out the Lights, the Party’s Over: Texas Legislature Takes All the Fun Out of the TCPA (5/28/19)

You might say whenever I’ve needed a hit, I’ve gone to the TCPA. It’s like a Beach Boys song about cars. Or Trump talking about Hillary’s emails.

And you can gather from my headlines the arc of the TCPA since its enactment in 2011.

From 2011-2017, it was an important but relatively obscure “anti-SLAPP” statute.

Then litigators figured something out. The definitions in the TCPA are so broad, that if applied literally, they cover almost any kind of lawsuit. Especially a departing employee suit, the focus of my law practice.

In 2017, the Austin Court of Appeals held in Elite Auto Body that the statute applied to a claim for misappropriation of trade secrets. The court reasoned that the Texas Supreme Court has mandated application of the “plain meaning” of the statute. Other Courts of Appeals—including Houston and Tyler—followed in 2018. And the Austin court continued to apply the statute broadly and literally in cases like Craig v. Tejas Promotions and Grant v. Pivot Technology.

But cracks in this plain-meaning foundation soon started to form.

The Houston Court of Appeals issued the Gaskamp opinion in late 2018. The majority said the TCPA applied to the allegation that a group of employees conspired to take their employer’s confidential information and trade secrets to a competing venture. But Justice Jennings wrote a concurring opinion arguing that this was a misguided misapplication of the doctrine of textualism. The TCPA was never intended to apply to any of the claims in the case, he wrote, and applying the literal meaning of the statute’s broad definitions would lead to “absurd or nonsensical results.”

Picking up where Justice Jennings left off, the Metroplex courts started to reign in the TCPA. The Fort Worth Court of Appeals went the textualist route in Kawcak, diving deep into several dictionaries to support its holding that a business conspiracy between only two people is not a “common interest” as defined in the statute.

Dyer Straits

Then the Dallas Court of Appeals got to the same place through a different route—blowing open the “absurd results” escape hatch. It held in Dyer that it would be nonsensical and absurd to apply the TCPA’s literally to claims against departing employees that do not implicate public participation.

This led to a slew of Dallas opinions holding that the TCPA does not apply to essentially private business disputes: Dallas Court of Appeals opinions restricting the TCPA have been coming out more often than those “Fast and Furious” movies.

Then it was the legislature’s turn. House Bill 2730 significantly restricted the scope of the TCPA, in two ways. First, it narrowed the TCPA’s definitions of “right of free speech” and “right of association.” Second, it exempted several types of claims, including most non-compete, trade secret, and common-law fraud claims.

Klocked Out

The next carve-back of the TCPA came from an unlikely source: the U.S. Court of Appeals for the Fifth Circuit. It held in Klocke v. Watson that the TCPA does not apply in federal court.

Now we await the Texas Supreme Court’s decision in Pivot Technology v. Grant, which may clarify the scope of the “right of association” and could also address whether the Texas non-compete statute preempts the TCPA. But those issues will become largely moot for other cases, due to House Bill 2730.

So where does this leave us? Many questions remain unanswered, especially issues of procedure.

For example, I recently filed a TCPA motion to dismiss a Rule 202 petition for a pre-suit deposition. There is a split of authority on whether such a petition is a “legal action” under the TCPA. See Hughes v. Giammanco, __ S.W.3d __, 2019 WL 2292990, at *4-10 (Tex. App.—Houston [1st Dist] May 30, 2019, no pet. h.) (Rule 202 petition is not a “legal action”); DeAngelis v. Protective Parents Colation, 556 S.W.3d 836, 849 (Tex. App.—Fort Worth 2018, no pet.) (Rule 202 petition is a “legal action”). We don’t know where the Texas Supreme Court will come out on that.

And we don’t know how Texas courts will apply the statute’s new definitions of free speech and association.

But we do know the TCPA generally does not apply to the following kinds of cases, among others:

Federal court
Trade secret
Non-disparagement
Non-compete
Family Code Titles 1-5
DTPA
Eviction
Common-law fraud
“Commercial speech” (further defined in the Castleman case)

I say the TCPA “generally” does not apply to these types of cases because there are exceptions, so be sure to read the statute carefully. Still, these categories cover a lot of real estate.

The Preemption Predicament

For my practice, which focuses on non-compete and trade secret disputes, it doesn’t leave much room for filing a TCPA motion to dismiss. The typical departing employee suit includes a claim that a former employee breached a non-compete, or misappropriated trade secrets, or both. Starting September 1, the TCPA won’t apply to those claims.

You might still have a shot at a TCPA motion against other claims. Breach of fiduciary duty is another common cause of action in a departing employee suit. Maybe you can file a motion to dismiss that claim alone–and if you lose still get a stay of the whole case during your interlocutory appeal (?).

But you’ll have to fit the square peg of breach of fiduciary duty into the round holes of “right of free speech” and “right of association,” which are now smaller thanks to HB 2730.

And breach of fiduciary duty is already a shrinking cause of action in departing employee cases. That’s because a common-law fiduciary duty claim that is based on misappropriation of trade secrets is preempted by the Texas Uniform Trade Secrets Act (as I explained here).

And if you’re in federal court? Forget about it. You’ve been Klocked.

So for now, I’m breaking up with the TCPA. I’m sorry, TCPA, but I’m just not that into you anymore.

Don’t take it too hard. We’ll always have Austin.

__________________________________

Mysteries of Texas Non-Compete Law, Part 3: Irreparable Injury

The celebration of the 30th anniversary of the Texas non-compete statute continues with this week’s unanswered question of Texas non-compete law: does the loss of sales caused by a breach of a non-compete establish “irreparable injury”?

Paper Rules vs. Real Rules

I confess this is actually an answered question. It’s just that the answer is not obvious. That’s because the court opinions aren’t necessarily going to tell you the answer, at least not explicitly.

You see, in law there are the Paper Rules, and there are the Real Rules.

The Paper Rules are the reasons courts put on paper for ruling the way they do. The Real Rules are the actual reasons the courts decide cases the way they do.

If that sounds sinister, don’t worry. The Paper Rules and the Real Rules overlap. If you drew a Venn diagram it would show two overlapping circles. And the circles constantly shift, because sometimes the courts incorporate some of the Real Rules into the Paper Rules.

That’s kind of what the smart people at the American Law Institute do when they write a “Restatement” of a certain area of law. They look at dozens of court decisions and say “here’s how courts actually decide this issue,” and then they make that principle one of the Paper Rules.

That’s why it’s the Restatement (Second) of the Law of Contracts and not the Statement (Second) of the Law of Contracts. The whole project has a certain aroma of legal realism.

Of course, you can always “out-realist” the realists. You can say, “Ha! you think judges are deciding these cases based on what they think is reasonable, I say it’s based on who contributed to their campaigns!” Or based on what will keep the proletariat in his place, or increase economic efficiency, or maintain the patriarchy, etc.

That’s a deeper part of the ocean. Here I’m focusing on the surface level of the Real Rules, the legitimate “legal” reasons courts decide cases a certain way.

If you’re a practicing litigator, you need to understand both the Paper Rules and the Real Rules. You have to be fluent in the Paper Rules to brief and argue your case. But you also need to understand the Real Rules, because then you will know what you really need to prove to win your case, and you will increase your chances of accurately predicting what’s going to happen.

This is especially true in non-compete litigation. Even if you read a lot of non-compete injunction opinions, you might miss the answer to the irreparable injury question if you only pay attention to the Paper Rules.

What the Real Rule is

The Real Rule is that loss of customers establishes “irreparable injury” if the trial court judge wants it to. Otherwise, it doesn’t. You can sum up the reason for this answer in three words: standard of review.

Let’s break it down in ten simple steps:

1. The Texas non-compete statute authorizes judges to award “injunctive relief” for the breach of a non-compete.[1]

2. Injunctive relief includes a temporary injunction (in federal court it’s called a preliminary injunction).

3. A temporary injunction is an order from the trial court judge that says, for example, “Salesman may not do business with Former Employer’s Customers until this court renders a final judgment after trial.”

4. A temporary injunction is a common-law remedy. That means that judges, through case law, have established the requirements for a temporary injunction through decades, even centuries, of case law.

5. The common-law requirements for obtaining a temporary injunction include “irreparable injury,” or irreparable harm, and “no adequate remedy at law.” These requirements apply to non-compete cases.[2]

6. Irreparable injury and no adequate remedy at law mean essentially the same thing: money damages would be inadequate to compensate for the lost sales.

7. If the trial court rules against you on a temporary injunction, you get an interlocutory appeal, which is an appeal taken before the trial court has rendered a final judgment.[3]

8. The “standard of review” for an interlocutory appeal of a temporary injunction ruling is “abuse of discretion.”[4]

9. Abuse of discretion means even if the Court of Appeals thinks the trial court judge got it wrong, it will affirm the ruling as long as there was a reasonable basis for it.

10. There are cases saying that the loss of customer sales establishes irreparable injury.[5] There are other cases saying it doesn’t.[6]

Maybe this difference can be reconciled based on the different facts of the cases. Maybe it can’t. But either way, you can see where this is headed.

Here is the practical result:

A. In a non-compete case, the trial court judge will usually decide the temporary injunction based on what the judge thinks is fair.

B. If the trial court judge grants a temporary injunction, the Court of Appeals will almost always say the judge could have reasonably found that the loss of customers established irreparable injury.

C. If the trial court judge denies a temporary injunction, the Court of Appeals will almost always say the judge could have reasonably found that the loss of customers did not establish irreparable injury, because the loss could be adequately compensated by damages.

The bottom line is that the irreparable injury requirement is effectively a variable that the trial court judge can use to justify whatever decision the judge thinks is fair. This is the Real Rule in non-compete litigation.

Mind you, it’s only a general rule. It is possible to persuade an appellate court that the trial court abused its discretion, but it is rare. And even when an appellate court reverses a trial court’s ruling on a temporary injunction, it’s usually based on some other issue, not the irreparable injury requirement.

So now you know the Paper Rules and the Real Rule on irreparable injury in non-compete cases. Mystery solved.

What the Real Rule should be

But what should the rule be? Should the loss of sales establish irreparable injury?

I say generally, no, for two main reasons. First is the almost-forgotten principle of “efficient breach.” Second is the almost-forgotten constituency in non-compete cases: the customers.

Efficient breach is a concept you learn in law school and then never hear about, unless you go into academia or clerk for the Seventh Circuit. Black’s Law Dictionary defines efficient breach as the “modern contract theory which [sic] holds that it may be economically efficient to breach a contract and pay damages.”

The idea of efficient breach reflects the amoral bent of modern contract law. 1Ls learn that contract law is about commerce and efficiency. It’s not about right and wrong. There’s nothing inherently immoral about breaking a contract. Efficient breach says it’s fine to break a deal as long as you compensate the other party for its damages and still come out ahead.

Of course, most people, including judges, don’t really think like this. Courts even refer to contractual promises as covenants. Talk about a word with some moral baggage! Truth is, there is always a tension between the moral and amoral strands of contract law.

So when the Law and Economics movement started promoting the concept of efficient breach in the 1970s, it was only partly descriptive, and retroactively so.

It was descriptive in the sense that it provided a rationale for certain timeworn principles of contract law. You might recognize one of those principles: the irreparable injury requirement.

The efficient breach theory provided an economic explanation for the irreparable injury requirement: courts will refrain from enjoining a party from breaching a contract, as long as the injured party can be made whole with damages, because that’s more economically efficient.

That’s the descriptive part. The prescriptive part is the idea that courts should refrain from granting an injunction when damages would be adequate to compensate the injured party.

This doesn’t mean you have to be a Law and Economics type to appreciate the efficient breach theory. For me, the value of the theory is that it helps us discern when we are deciding cases based on moral considerations as opposed to the amoral rules of the marketplace.

You see this a lot in non-compete cases. In most cases, when a sale person breaks a non-compete and her employer loses sales, damages are not that hard to calculate and would adequately compensate the employer.

So what explains why a judge would grant an injunction in such a case?

I think it’s the moral element. Specifically, it’s the notion of loyalty. Breaking a non-compete is not just some antiseptic breach of contract, the judge thinks, it’s a breach of loyalty. It’s a betrayal.

And I get that. But the problem, in practice, is that loyalty tends to be a one-way street in employment relationships. We expect loyalty from the employee, but where is the loyalty when the employer fires the at-will employee for an unfair reason, or for no reason?

I say non-compete litigation could use a little more of the efficient breach theory, and a little less of the moralizing. That means don’t grant an injunction to prevent the loss of sales unless the damage is truly irreparable, e.g. if the loss of sales would put the company entirely out of business.

Unless I represent the employer trying to enforce the non-compete. Then let the moralizing flow.

Who will speak for the customers?

The second reason I think it’s wrong to grant an injunction to prevent an ordinary loss of sales is that it unfairly restricts the rights of non-parties. Specifically, the customers. Or if it’s a professional service, the clients.

Yes, customers and clients. Remember them? They pay the bills.

When a judge orders a sales person to stop doing business with certain customers, that is effectively the same as ordering the customers not to do business with the sales person.

Let that sink in. A temporary injunction tells a customer you can’t get your lumber, or insurance policy, or oilfield services—or whatever it is—from the person you like. And in many cases, that’s the person you’ve bought that thing from for years.

Think about it. The customer never signed any non-compete. The customer is not a party to the lawsuit. And in most cases, the customer hasn’t done anything wrong. But a judge is going to tell the customer what to do?

Now I may be just a small-time Texas litigator, but that don’t seem right. This is just my personal opinion, but I say protecting the interests of customers is a compelling reason for strictly enforcing the irreparable injury requirement in non-compete litigation.

Don’t get me wrong. If the non-compete is reasonable and enforceable, the employer can still get damages. Specifically, the employer can recover lost profits damages, if proven with reasonable certainty.

But wait a minute, you say. What about the cost of pursuing damages in a lawsuit? The attorneys’ fees, the expert witness fees, the time and uncertainty of the litigation process. You don’t get those things back.

Ah, transaction costs. The bane of the efficient breach theory.

All I can say is, transaction costs are an inherent problem in any litigation. That’s why cases settle.

That’s another one of the Real Rules.

_______________________________

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] Tex. Bus. & Com. Code § 15.51(a).

[2] Some Texas courts have held that irreparable injury and the other common-law requirements do not apply to a claim for a permanent injunction to enforce a non-compete. See the discussion in Tranter, Inc. v. Liss, No. 02-13-00167-CV, 2014 WL 1257278, at *6-7 (Tex. App.—Fort Worth Mar. 27, 2014, no pet.) (mem. op.).

[3] Tex. Civ. Prac. & Rem. Code § 51.014(a)(4) (state court); 28 U.S.C. § 1292(a)(1) (federal court).

[4] See, e.g., Argo Group US, Inc. v. Levinson, 468 S.W.3d 698, 700 (Tex. App.—San Antonio 2015, no pet.) (“In this interlocutory appeal, our review is limited to determining whether the trial court abused its discretion in denying Argo’s request for a temporary injunction”); Cardoni v. Prosperity Bank, 805 F.3d 573, 579 (5th Cir. 2015) (“We review a district court’s assessment of these factors [that a party seeking an injunction must show] for abuse of discretion. Conclusions of fact that affect that analysis are left undisturbed unless clearly erroneous, whereas conclusions of law are reviewed de novo.”)

[5] See, e.g., Cardinal Health Staffing Network, Inc. v. Bowen, 106 S.W.3d 230, 236 (Tex. App.—Houston [1st Dist.] 2003, no pet.) (“proof that a highly trained employee is continuing to breach a non-competition covenant gives rise to a rebuttable presumption that the applicant is suffering irreparable injury”); Tranter, 2014 WL 1257278, at *7 (“A highly trained employee’s continued breach of a noncompete agreement creates a rebuttable presumption that the employer is suffering an irreparable injury”).

[6] See, e.g., Argo Group US, Inc. v. Levinson, 468 S.W.3d 698, 704-5 (Tex. App.—San Antonio 2015, no pet.) (affirming trial court’s denial of temporary injunction where trial court could have reasonably found no threat of irreparable injury); Midstate Environmental Services LP v. Atkinson, No. 13-17-00190-CV, 2017 WL 6379796, at *4 (Tex. App.—Corpus Christi 2017, no pet.) (mem. op.) (affirming trial court’s denial of a temporary injunction to enforce a non-compete based on lack of irreparable injury, where damages could be calculated based on the proceeds plaintiff would have received for customers that switched to the competitor); Am. Mortgage & Equity Consultants, Inc. v. Bowersock, No. 1:19-CV-492-RP, 2019 WL 2250170, at *5 (W.D. Tex. May 24, 2019) (denying TRO for misappropriation of customer information where the court would be able to calculate damages for resulting from the “converted” customers); BMC Software, Inc. v. Int’l Business Machines Corp., No. H-17-2254, 2018 WL 4520020, at *4-5 (S.D. Tex. Sept. 21, 2018) (denying preliminary injunction where alleged loss of customer could be compensated by money damages).

One Law Dude’s Reflections on #MeToo, and Seinfeld

You have to feel bad for us men in the workplace these days, what with the #MeToo movement and everything. I mean, we just don’t know what we’re allowed to say or do anymore.

Can you hold the door open for a lady at the office? Compliment a woman on her new dress? Roll up to the parking garage blasting “Panama” on the car stereo?

Of course, back in the “good old days,” things were not so good for women in the workplace. There was plenty of overt sexism. It was wrong, but at least the rules of polite society were better defined.

That all changed beginning with the social upheavals of the 60s. Now everything’s upside down, and we need somebody to tell us the new rules.

Fortunately, there was a TV show in the 90s that examined the new social rules, sometimes in minute detail. It was billed as a “show about nothing,” but it was actually a meticulous comedy of manners.

Seinfeld was brilliant because it explored the social world’s unique standards of conduct. You don’t want to be one of those “low talkers.” You don’t make out with your date during Schindler’s List. You stand at a certain distance behind someone at the ATM. You certainly don’t double dip.

At the same time, Seinfeld showed that these norms cannot be reduced to a code of conduct with rules, sub-rules, exceptions, and counter-exceptions. This is what distinguishes manners from the law, or at least from what the law wants to be. It’s why someone with autism might be able to memorize the NFL rulebook but struggle with simple social cues.

And it’s why us guys might have a hard time grasping the new rules for how to interact with women. Take George Costanza, for example. In Season 5, Episode 4, “The Sniffing Accountant,” George gets a lesson in appropriate workplace conduct.

In the opening scene, Elaine gushes over her new boyfriend. They met at the office:

Elaine: So, I was sitting at the reception desk, I was looking pretty hot. I was wearing my sling back pumps.

George: What are those?

Elaine: Ask your mother, you live with her now, don’t you? Anyway, so then this guy comes up to me and starts feeling my jacket through his thumb and his forefinger, like this.

Jerry: So, what did you do?

Elaine: I said, “So, what do you think?” And he said, “Gabardine?” And I said, “Yeah.” That was it.

George: Wow, just felt your material?

Elaine: Yeah, Jake Jarmel.

George: Sounds like a cool guy.

Later, George decides to try out Jake’s maneuver. After a successful job interview with Mr. Farkus for a position as a brassiere salesman, George is on a roll as he waits for the elevator. There’s an attractive woman standing next to him, so he reaches out and touches the sleeve of her jacket. It does not go well:

Ms. De Granmont: What do you think you’re doing?

George: Oh, nothing.

Ms. De Granmont: Farkus, get out here!

Farkus: Yes, Ms. De Granmont?

Ms. De Granmont: Who is this perverted little weasel?

Farkus: This is Costanza, he’s our new bra salesman. He’s supposed to start on Monday.

Ms. De Granmont: If he’s here on Monday, you’re not. Take your pick.

Farkus to George: Get out!

You have to pity George. When Jake pulled this move on Elaine, it was charming. But when George tries the same thing, it’s just creepy.

How is this fair? What is the applicable rule?

The problem, of course, is that all men are not created equal. Jake is handsome and smooth. George is short and bald and awkward. But you couldn’t have an employee handbook that says “debonair men may touch women’s clothing and comment on it; others are prohibited.”

That’s the difference between manners and law. This episode teaches us two things about social conventions: they are hard to rigorously define, and they are decidedly unequal as applied to different people.

This is just not fair, us dudes tend to think. How are we supposed to navigate the gray areas of acceptable conduct towards women?

You hear this kind of complaint a lot from certain guys. But then a funny thing happened on the way to Monk’s Diner. The #MeToo movement exploded, and it exposed an ugly truth: a lot of men have done a lot of really horrible things to women at work.

Let’s just take some of the obvious public examples:

Harvey Weinstein
Matt Lauer
Al Franken
Bill Cosby
Donald Trump

Obviously, some of their alleged offenses were worse than others. But all of them have one thing in common: these men allegedly did things that everybody knows you shouldn’t do. These things were wrong before the Sexual Revolution, and they are wrong after it. They are not gray areas.

Not only that, I’d wager that part of the attraction for these men was knowing the things were wrong. That’s the whole point. Proving you’re a big shot guy who can take advantage of women and get away with it. “When you’re a celebrity they let you do it.”

Of course, everyone is innocent until proven guilty . . . yadda, yadda, yadda. But let’s assume for the sake of argument these men did the things they’re accused of. One defense they cannot assert in good faith is “I didn’t know it was wrong.”

That’s why the common lament of “we just don’t know what’s ok anymore” rings a little hollow to me.

And that brings me back to Seinfeld. Specifically, Season 3, Episode 12, “The Red Dot.” It’s another one of George’s misadventures at work. George has an affair with the cleaning lady at his office, leading to this confrontation with the boss:

Boss: I’m going to get right to the point. It has come to my attention that you and the cleaning woman have engaged in sexual intercourse on the desk in your office. Is that correct?

George: Who said that?

Boss: She did.

George: Was that wrong? [audience laughs . . .] Should I have not done that? I tell you I gotta plead ignorance on this thing because if anyone had said anything to me at all when I first started here that that sort of thing was frowned upon, [more laughs] you know, cause I’ve worked in a lot of offices and I tell you people do that all the time.

Boss: You’re fired.

This time we don’t pity George at all. It’s not like the fabric incident at the brassiere company, where we laughed because George was so pitiful. In this case, the “was that wrong?” line gets laughs precisely because it’s so absurd. Of course it was wrong!

And once again, Seinfeld delivers an insightful lesson about social norms. Some rules don’t have to be written down; they’re just obvious. The employee handbook doesn’t need to say “employees may not have sexual relations with the housekeeping staff in the office.”

So men, here’s my modest proposal on sexual harassment: let’s agree not to tolerate the stuff we all know is wrong, and not complain so much that there will inevitably be borderline cases.

Don’t get me wrong. I’m not saying that women should just chill about the minor incidents and only complain about major felonies. I’ve got a wife, a mom, sisters, a college-age daughter–I don’t want them or any woman to be subjected to even minor incidents of harassment.

I’m also not saying that men are totally off base when they complain that the standards are so ill-defined today. There is at least a grain of truth to that.

But maybe us guys could focus more on cutting out the stuff we know is bad. I think #MeToo has done a great service by shining a light on those things.

Was that wrong?

________________________________

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

Thanks to Rebecca Wolfe and Hailey Wolfe for their advice on my initial draft (though I bear full responsibility for the final content).

Mysteries of Texas Non-Compete Law, Part 2: Reformation

We’re celebrating the 30th anniversary of the Texas non-compete statute by examining some of the great unanswered questions of Texas non-compete law. Part 1 asked whether it matters if the information provided by the employer is really confidential. This Part 2 asks whether reformation is available when the non-compete is missing a key limitation.

Are you studying for the California bar exam? If so, you probably know that the California Bar announced that it “inadvertently” leaked this year’s bar exam topics to a group of law school deans. To be fair to all test takers, the bar examiners decided to release the list of topics publicly.

I’m sure everyone studying for the California bar feels much better now.

In light of this disturbing news, I must come clean and disclose a phone call I recently received:

[ring tone: guitar intro to Sweet Child of Mine]

“Wolfe here.”

“Yes, hi, this is the Texas Board of Law Examiners. For the first time ever, we’re including a question about non-compete litigation on the bar exam this year. We were hoping we could run it by you.”

“Oh, cool, and you’re calling me because you saw my blog Five Minute Law and my YouTube channel That Non-Compete Lawyer?”

“Uh . . . well, actually you’re the ninth person we’ve tried. Everyone else is on vacation.”

“Ok, cool. Send it over.”*

The problem is that I know a few Texas law students through my local Inn of Court, so I could be accused of leaking the question to them. To avoid any appearance of impropriety, I am now making the question available to my readers—all thirteen of them (hi, Mom!).

Ok, Fivers, here’s the question:

W&O Supply Company sells supplies like the Garbarino centrifugal and positive displacement pump to the marine industry. Four of W&O’s employees—a branch manager, outside salesman, warehouse manager, and inside salesman—left W&O to start a competing business.

Each employee had signed W&O’s standard non-compete. The non-compete prohibits diverting, or assisting in diverting, any customer from W&O to a competitor. The non-compete is limited to any area within 100 miles of any W&O branch but contains no time limitation.

While working for W&O, the employees received confidential information regarding W&O’s supplier costs, customer purchasing history, and pricing. After leaving W&O and forming the competing business, the employees solicited sales from W&O customers.

W&O filed suit against the former employees in U.S. District Court in Houston, Texas, alleging breach of the non-competes and seeking a preliminary injunction. The employees filed a motion to dismiss for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6), arguing the non-compete is unenforceable on its face because it contains no time limitation.

W&O filed a response arguing that the non-compete statute requires the court to reform the non-compete to include a reasonable time limitation and that, even without reformation, the court could still grant a preliminary injunction enforcing the non-compete for a reasonable time period.

The correct ruling on the motion is:

A. Denied. W&O’s allegations are sufficient to state a plausible claim for relief. W&O could prove some set of facts showing that a time limitation of a year is reasonable.

B. Denied. Reformation of an overbroad non-compete is mandatory under the Texas non-compete statute, Tex. Bus. & Com. Code § 15.51(c).

C. Denied. The court can enter a preliminary injunction enforcing the non-compete to a limited extent. Whether the non-compete should be reformed is an issue for final judgment.

D. Granted. While the non-compete statute requires the court to reform a time limitation that is too long, the court cannot reform a non-compete that contains no time limitation whatsoever.

So what’s the best answer? No peeking.

Ha! It’s a trick question! You could make a reasonable case for each one of these answers. That’s why it’s an unanswered question of Texas non-compete law. No question like this should ever appear on the bar exam.

But if you ask U.S. District Judge Kenneth Hoyt, he would say D is the best answer. I know that because I’ve read his opinion in W&O Supply, Inc. v. Pitre, No. 4:19-CV-00153, 2019 WL 15592090 (S.D. Tex. Apr. 10, 2019).

The facts of the case were fairly close to the simplified version I outlined above. The key fact: the non-competes had no time limitation. The legal question was whether W&O was entitled to reformation. Specifically, should the judge effectively “rewrite” the agreement to add a reasonable time limitation?

Because we are all textualists now, let us start with the text of the statute. It says, in pertinent part:

If the covenant . . . contains limitations as to time, geographical area, or scope of activity to be restrained that are not reasonable and impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee, the court shall reform the covenant to the extent necessary to cause the limitations contained in the covenant as to time, geographical area, and scope of activity to be restrained to be reasonable . . .

Tex. Bus. & Com. Code § 15.51(c).

The “shall reform” language indicates the legislature intended reformation to be mandatory. But the clause starts with a significant “if.” Reformation is only mandatory if the non-compete “contains limitations as to time, geographical area, or scope of activity to be restrained . . .”

That “if” clause is what we call a “condition precedent” (which, to complicate matters further, is pronounced pree-see-dent, not preh-suh-dent). That means the rest of the clause only applies if the condition is met.

So, if a non-compete has limitations that are unreasonably broad, the condition precedent is satisfied, and reformation is mandatory. But if the non-compete has no time limitation whatsoever, then the condition precedent is not met, and reformation is not required.

That’s effectively what the employees in W&O Supply argued, and the judge agreed:

It is the Court’s view that it is empowered only to reform existing terms. Where the Agreement lacks a critical term, such as a time limitation, placing a time limitation in the Agreement is to rewrite the Agreement. The Agreement lacks an unenforceable provision that the Court can revise; therefore, reformation is impermissible.

W&O Supply, 2019 WL 15592090, at *3.

The unavailability of reformation was not academic. Because the non-competes were unenforceable and could not be reformed, the court not only denied a preliminary injunction, it dismissed the lawsuit. Id.

So why is the availability of reformation an unanswered question?

Well, W&O Supply is just one case, and there are other arguments that could be made.

First, you could argue that the court in W&O Supply read the non-compete statute too literally. The purpose of the statute is to provide for reformation of overbroad non-competes. One might argue this purpose should be served as much when the agreement lacks a limitation as when the limitation is too broad.

Second, there are cases saying the court can enter a preliminary or temporary injunction enforcing an overbroad non-compete to a limited extent. See, e.g., Transperfect Translations, Inc. v. Leslie, 594 F.Supp.2d 742, 756 (S.D. Tex. 2009) (noting uncertainty in Texas cases and holding that the non-compete would be temporarily reformed for the purpose of entering a preliminary injunction).

Third, the statute also requires a geographic limitation. See Tranter Inc. v. Liss, No. 02-13-00167-CV, 2014 WL 1257278, at *5 (Tex. App.—Fort Worth Mar. 27, 2014) (non-compete that contained no geographic restriction at all was unreasonable and unenforceable as written). Yet there are cases enforcing non-competes that contain no geographic limitation whatsoever. See Gallagher Healthcare Ins. Servs. v. Vogelsang, 312 S.W.3d 640, 654-55 (Tex. App.—Houston [1st Dist.] 2009, pet. denied) (“A number of courts have held that a non-compete covenant that is limited to the employee’s clients is a reasonable alternative to a geographical limit”).

If the absence of a geographic limitation is not fatal to a non-compete, why should the absence of a time limitation be any different?

They’re going to put that one in the essay section.