A Texas non-compete litigator points out the biggest problems with the way non-competes work in practice
There are too many non-competes, the non-competes are too broad, and judges are too willing to enforce them with injunctions.
That’s just my opinion, but I’m not the only one worried about non-competes. In November 2019, the American Constitution Society (ACS) released an Issue Brief titled “No Exit: Understanding Employee Non-Competes and Identifying Best Practices to Limit Their Overuse.” It covered the traditional legal framework governing non-competes, explored why an increasing number of workers are subject to them, summarized some legislative responses, and explored non-legislative approaches to combating the overuse of non-competes.
The ACS took a dim view of the widespread use of non-competes, especially for lower-level employees like janitors and sandwich makers. “Taken in the aggregate,” the brief argued, “such widespread limitations on employee mobility have demonstrable, negative consequences for wages and innovation.”
At the federal level, the ACS brief reported, the proposed Workforce Mobility Act of 2019 would have banned the use of non-competes, with some limited exceptions permitting non-competes for owners or senior executives in the sale of a business or dissolution of a partnership. The issue brief concluded that policymakers in most states “should consider adopting stronger measures to discourage employer overuse of non-competes.”
The ACS brief approached non-compete reform with an obvious pro-worker orientation. As a lawyer who represents both employers and employees in non-compete disputes and litigation, I have more of a practitioner’s perspective. And as a Texas non-compete lawyer, I don’t expect any significant change in the law soon.
But my experience handling non-compete cases tells me that some common-sense reforms are overdue in the Lone Star State.
Here are the five biggest practical problems with non-competes that I’ve learned from handling Texas non-compete cases.
Disclaimer: This is, like, just my opinion, man. So you’re not allowed to cite this post against me if I’m trying to get an injunction against your client.
1. In the vast majority of cases an employee non-compete is not really bargained for.
Imagine this scenario. Dawn Davis is a single mom and a legal assistant at a big law firm in Dallas. She makes good money, but the hours are long, and her bosses are jerks. She finds an opportunity for a new career in sales: Paula Payne Windows offers her a job selling windows in the construction industry. There are only two problems: it’s for less money, initially, and she has to move to another city. Still, Dawn is ready for a change, so she accepts the offer.
Dawn scrapes together enough money to pay a deposit on a new apartment in a decent school district, packs everything in a U-Haul, and moves her two kids, a cat, and a turtle to Cedar Park. The next Monday, she shows up for work. “We’re so excited that you’re joining us,” her boss Paula Payne says, “I’ll just need you to sign a few documents, and then we can get you started on this prospect list.”
You see where this going.
We all know Dawn’s non-compete is not bargained-for in any meaningful way. What’s she going to do, say “I’m sorry I can’t sign this,” decline the job, and start looking for some other way she’s going to pay next month’s bills? She could do that in theory, but in practice she’s going to do what countless other Texas employees do in similar situations: sign the documents.
Unfortunately for Dawn, there won’t be any getting out of the non-compete. It may be unenforceable for other reasons, but not because it wasn’t bargained for. “Did anyone put a gun to your head and say you have to sign this agreement,” the lawyer for Paula Payne Windows will ask Dawn in her deposition years later. Unless Dawn can testify to some extreme circumstance like that, a Texas judge is not going to rule that the non-compete is void based on duress, unconscionability, or some similar defense.
This scenario is typical. I’ve handled a lot of non-compete matters, and it’s common for the employee not to see the non-compete until it’s practically too late. And even when the employee gets the non-compete agreement before accepting the job, it’s rare that there is actually any bargaining over the non-compete. See, e.g., TENS Rx, Inc. v. Hanis, No. 09-18-00217-CV, 2019 WL 6598174 (Tex. App.—Beaumont Dec. 5, 2019, no pet. h.) (mem. op.) (employee claimed she had reservations about the non-compete but signed it because the employer said it was just a formality).
Ok, but so what? Doesn’t the “no bargaining” objection prove too much? Yes, employees sign non-competes agreements that are not really bargained for, one could argue, but that’s true of all kinds of things at-will employees agree to, like binding arbitration. Yet we generally enforce those things. Why should non-competes be different?
Well, for one thing, it’s not just the interests of the employee at stake. It’s also the interests of customers and the public. Generally, employee mobility is a good thing for the economy. It’s a big reason we have the at-will employment rule in the first place.
One way you could fix the “no bargaining” problem is to require employers to give advance written notice that a job offer includes a non-compete. The ACS brief reports that some states have already enacted rules like this. But I can see this kind of rule leading to all kinds of complications.
There’s a simpler way to fix this problem: prohibit non-competes for at-will employees. You could still allow non-competes in the sale of a business, where the non-compete is actually bargained for, and it makes economic sense to give the buyer a way to acquire the goodwill of the business. The proposed federal legislation has an exception for this.
But this solution does not seem politically feasible in Texas at the moment. More about that later.
2. Employee non-competes hurt the employer by shifting its focus to the wrong thing.
The second problem with employee non-competes in practice is a little counter-intuitive: they hurt the employer.
The best form of non-compete is a happy employee who doesn’t want to leave. Successful entrepreneurs cite keeping employees happy as a key reason for success. If you require employees to sign non-competes, you’re feeding a mindset that focuses on the wrong thing, restricting employees, instead of the right thing, keeping your high performers happy.
Business owners will say I’m being naïve, but as I said in The Most Effective Form of Non-Compete in Texas, if you think a non-compete is going to keep your best people from leaving, who is being naïve?
Still, I get it. I represent employers too, and I understand why they want employees to sign non-competes. It is frustrating to pour time, effort, and money into developing your employees, their skills and knowledge, and their goodwill with customers or clients, only to see them leave as soon as they get a better offer. Sometimes there is even a strong sense of personal betrayal, which is only natural.
So I’m not saying employers should never require non-competes, nor am I saying non-competes should never be enforced (under current law). Confession: I have drafted non-competes for employees to sign and have even sued employees for breaking non-competes. [audience gasp]
On balance, though, an employer is better off focusing on employee retention than drafting an impenetrable non-compete.
Similarly, I’m not sure enforcement of non-competes is the “pro-business” position. When people say enforcing non-competes is pro-business, keep in mind there are usually two businesses in a non-compete dispute: the first employer and the second employer. The employee is usually going from one business to the other. Is it really “pro-business” to tell the second business it can’t hire the employee?
This is before we even get to the problem of the non-compete’s effect on the employee.
3. The cost of litigation has a chilling effect on employees challenging unreasonable non-competes.
Here’s how it usually goes down. Dawn Davis quits her job at Paula Payne Windows and starts up her own windows company. Paula Payne gets worried that Dawn is going to take customers and cut into Paula’s profits, so she has her lawyer send Dawn a nastygram. The letter demands that Dawn refrain from competing with Paula Payne for three years, as her non-compete requires.
What is Dawn to do? Her best option is to work something out in a settlement. Maybe the compromise is that Dawn agrees not to do business with certain customers. Or maybe she agrees to pay Paula Payne 25% of her profits from those customers for a year.
But what if Paula Payne plays hardball and says no, comply with your non-compete or we’re going to sue you and get an injunction to stop you from selling windows?
“What should I do?” Dawn asks her lawyer, Maria Reynolds. “Well this non-compete is clearly overbroad,” Reynolds tells her, “but if we have to go to court it’s going to be expensive.” “How expensive?” Dawn says. “I’m going to need a deposit of $10,000,” Reynolds says, “and that might be enough to get through the temporary injunction hearing in the first month.”
Variations on this scenario happen all the time. The cost of litigating a non-compete case is usually as much, or more, of a settlement factor than the substantive issues.
The cost of litigating tends to give the employer an advantage over the employee in a non-compete dispute. The employer usually has more money, and the employee more to lose. If the employer loses the temporary injunction round, it loses some attorneys’ fees and probably some profits from customers that follow the employee. If the employee loses, she pays attorneys’ fees and has to look for a new job. In the words of Private Hudson, “game over, man.”
The ACS report calls this the “in terrorem” effect of an overbroad non-compete (quoting venerable law professor Harlan Blake). I call it leverage.
Of course, the cost of litigation is also a factor for the company trying to enforce the non-compete, and the problem of litigation expense driving settlement is not exclusive to non-compete cases.
But there is something different about a non-compete lawsuit: it affects the rights of third parties. Namely, the customers.
4. Judges don’t give enough weight to the interests of the customers, who never signed any non-compete.
You know, the customers? They are the ones who pay for the goods or services. Without them, there would be no sales for the parties to the non-compete to fight over.
Well, what if I told you that Texas law allows a judge to enter an injunction against a customer, who never agreed to any non-compete, prohibiting the customer from doing business with an employee who did sign a non-compete?
No way, you would say. This is a free country. A judge can’t just order someone to comply with an agreement they never signed.
Of course, this is precisely the effect of an injunction that enforces an employee’s non-compete. Let’s say you’re Biff Henderson, a residential builder who has bought windows from Dawn Davis for seven years. The judge signs a temporary injunction against Dawn—and “all others acting in concert” with her—prohibiting her from doing business with any of the customers she served at Paula Payne Windows. That is effectively the same as the judge ordering Biff not to do business with Dawn.
I’ve seen a lot of non-compete cases, and I can tell you three things that are usually true about customers.
First, they didn’t sign any non-compete.
Second, customers usually want to keep buying stuff from the person they’ve been buying stuff from. They certainly don’t want a judge telling them they can’t buy from that person anymore.
Third, customers don’t want to get entangled in a lawsuit and spend money on legal fees. In theory, a customer could intervene in a non-compete lawsuit to protect its right to do business with who it wants. But who’s going to do that? Biff may love Dawn, but probably not enough to spend thousands of dollars on legal fees so he can keep buying windows from her.
The net result is that the system has to rely on the employee to speak for the customer in the non-compete lawsuit. And the employee’s lawyer will usually try to do so.
But in my experience, judges don’t give the interests of the customers enough weight. It even seems like some judges consider it routine to grant an injunction to enforce a non-compete.
They forget that an injunction is supposed to be an “extraordinary” remedy.
5. Judges don’t take the “irreparable injury” requirement seriously enough.
One of the traditional common-law requirements for a temporary injunction is irreparable injury. Irreparable means harm that cannot be adequately compensated by damages. In theory, this requirement applies to a temporary injunction enforcing a Texas non-compete. See Cardinal Health Staffing Network, Inc. v. Bowen, 106 S.W.3d 230, 241 (Tex. App.—Houston [1st Dist.] 2003, no pet.) (rejecting argument that proof of irreparable injury is not required in a non-compete case).
But the irreparable injury rule is quite elastic, and the Texas Courts of Appeals review temporary injunctions on an “abuse of discretion” standard. The end result is that trial courts can apply the rule as strictly or loosely as they want, and they will rarely be reversed.
So you get two basic views of applying the irreparable injury rule. The “loose” view starts from the general proposition—stated in many Texas cases—that damages are only “adequate” when they would be as convenient and efficient as an injunction. Then it adds the proposition that the loss of customer goodwill is inherently difficult to measure by a dollar amount. The result is that judges with this view will almost routinely grant a temporary injunction if there is evidence that the employee is taking the employer’s customers.
The “strict” view calls BS on the “no adequate remedy” argument. In your garden variety non-compete case, the financial harm to the employer is the loss of sales. It’s not that hard to measure the employer’s lost profits resulting from the loss of sales. Lost profits damages can compensate for that. You’ve got to have something more than that, the strict view says, to establish that the harm is irreparable.
(A recent Texas Supreme Court case provides some additional support for the strict view; see Irreparable Injury, I presume?)
Both views can find support in the case law. But as should be obvious by now, I personally find the strict view more persuasive. I’ve already covered one reason above: the loose view doesn’t give enough weight to the interests of the customers.
But there’s an even more fundamental problem with the loose interpretation of irreparable injury: it ignores the irreparable injury resulting to the employee if the judge gets is wrong.
Keep in mind, a temporary injunction is not a final ruling on the merits. The parties are entitled to obtain discovery and present their best evidence at a full-blown trial. So at the temporary injunction hearing, the judge is sort of “guessing” at the employer’s likelihood of success at trial.
The problem is that the risks of guessing wrong are asymmetrical.
Here’s what I mean. If the trial court guesses wrong and denies a temporary injunction, the employer still has a remedy. Even if a bunch of customers run off with Dawn Davis while the lawsuit against her is pending, Paula Payne Windows can have the last laugh by seeking lost profits damages at trial.
But if the trial court guesses wrong and grants a temporary injunction, Dawn is out of luck. Worst case, her new employer Real Cheap Windows may decide it just has to let her go. Then she’s going to be looking for another job. It won’t matter if it turns out she was right that the non-compete was unenforceable; Dawn won’t get compensated for missing out on the sales she could have made absent the injunction.
Here’s another way to look at it. Even if the employer turns out to be right, the employee’s violation of the non-compete could be considered an “efficient breach.” The law should allow parties to breach a contract, the efficient breach theory says, as long as the non-breaching party can be compensated by damages.
That’s kind of the point of the irreparable injury rule in the first place, isn’t it?
I come out generally on the same side as the ACS issue brief. We need to reign in non-competes more in Texas. But it does not appear politically feasible that this will happen in the current Texas legislature. That means it’s up to Texas judges to give more weight to the interest of customers and to take the irreparable injury rule more seriously. This can be done without changing the Texas non-compete statute. It only requires applying the statute with common sense and some awareness of the way non-competes actually work in practice.
Zach Wolfe (email@example.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Thomson Reuters named him a 2020 Texas “Super Lawyer”® for Business Litigation.
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.