Let the Light In: The Legacy of the Most Famous Texas Non-Compete Case

Let the Light In: The Legacy of the Most Famous Texas Non-Compete Case

When I started practicing law in Texas in the 90s, the key non-compete case was Light v. Centel Cellular Company of Texas, 883 S.W.2d 642 (Tex. 1994). Light held that a non-compete in an at-will employment agreement was unenforceable because it was not “ancillary” to an otherwise enforceable agreement, as required by the Texas non-compete statute. We spent the next decade arguing about what that means.

Today, Light is not such a big deal, as subsequent decisions have largely abandoned it. You might say it’s the Pennoyer v. Neff of Texas non-compete law, in that it presents a dilemma for anyone teaching the subject. Does Light only deserve a brief mention, considering it is now largely obsolete, or is it worth getting down in the weeds and understanding all of its nuances and the subsequent decisions that tried to apply it?

I’m opting for a middle approach. You can find other articles that get down in the weeds. And sure, it would be fun to chronicle the 90s turf battle between the Texas Supreme Court and the Texas legislature over non-competes (see the snark in Light‘s footnote 7, for example).

But I’m just going to focus on three key hurdles Light created for enforcement of non-competes: (1) the “illusory contract” problem; (2) the “give rise to” requirement; and (3) the “designed to enforce” requirement.

The Texas Supreme Court would later knock down two of these hurdles, but one remains (maybe).

The “illusory contract” problem

Let’s start with the illusory contract problem. Light reasoned that an agreement to provide at-will employment cannot not be the “enforceable agreement” in “ancillary to an otherwise enforceable agreement” because the agreement is not really enforceable by the employee. “Describing something as an at-will obligation is nonsensical,” Light said. Id. at 645 n.7.

You can see the logic. If the employer can fire the employee at any time for any reason or for no reason, then what rights does the employee actually have to enforce? Thus, Light said that an agreement to provide at-will employment cannot be the “otherwise enforceable agreement” to satisfy the “ancillary to an otherwise enforceable agreement” requirement. See id. at 644-46.

Did this mean an at-will employee cannot have an enforceable non-compete?

No. Light made it clear that an otherwise enforceable agreement “can emanate from at-will employment so long as the consideration for any promise is not illusory.” Id. at 645.

This theorizing about illusory promises was all well and good, but employers just wanted to know, how do we meet this “ancillary” requirement if an agreement to provide at-will employment is illusory? The Light opinion gave them an answer in its famous footnote 14: an employer’s agreement to provide an employee confidential information or trade secrets can be the “otherwise enforceable agreement.”

Predictably, that is exactly how employers tried to make non-competes stick after Light. The standard form of non-compete would have a non-compete tied to a confidentiality agreement.

But there was a problem, one based on the reasoning of Light itself. If the employment is at will, isn’t the employer’s agreement to provide the employee confidential information also “illusory”?

That objection was correct in theory, but unworkable in practice. What are we supposed to do, exasperated employers asked, draft the contract to require handing the employee a stack of confidential documents at the moment she signs the contract? And believe me, there was much confusion and uncertainty.

The Texas Supreme Court later cleared this up. The Alex Sheshunoff case solved the “illusory contract” problem by holding that an agreement to provide confidential information to an at-will employee becomes an “otherwise enforceable agreement” when the employer performs its obligation to provide the confidential information. Alex Sheshunoff Mgmt. Servs., L.P. v. Johnson, 209 S.W.3d 644, 655 (Tex. 2006). Thus, the “illusory contract” problem addressed in Light was largely solved.

And this was probably a good thing. Like I said, the “illusory contract” point made some sense in theory, but it caused a lot of confusion, which Sheshunoff cleared up.

The “give rise to” requirement

Light also grappled with the meaning of “ancillary.” What does it mean for a non-compete to be “ancillary” to an otherwise enforceable agreement?

We could look up “ancillary” in a dictionary, but I say it’s more important to understand the purpose of the requirement. So let’s step back and ask a more fundamental question: what is the point of the “ancillary” requirement in the first place?

Put simply, the purpose of the “ancillary” requirement is to balance two interests: the interest in enforcing the contracts of private parties and the interest in encouraging free competition.

Let’s illustrate. Imagine you’re an ice delivery business in the 1920s making huge profits. (See Jurassic Non-Competes.) The last thing you want is for a salesman to quit and start selling ice to your customers. So any time an employee quits, you offer to pay him $500 in exchange for agreeing not to compete for a year.

That would be a “naked” non-compete, i.e. a non-compete that is not “ancillary” to an otherwise enforceable agreement, and we don’t want that. In that scenario, we give more weight to the interest in free competition than the interest in enforcing contracts.

So, the “ancillary” requirement has to mean something more than requiring the non-compete in exchange for some benefit provided to the employee. But what?

Citing to the US Supreme Court, the Restatement (Second) of Contracts, and its own decision in DeSantis v. Wackenhut, the Texas Supreme Court reasoned in Light that “ancillary” means two things:

(1) the consideration given by the employer in the otherwise enforceable agreement must give rise to the employer’s interest in restraining the employee from competing; and

(2) the covenant must be designed to enforce the employee’s consideration or return promise in the otherwise enforceable agreement.

Id. at 647.

To illustrate the first prong, the “give rise to” requirement, Light cited the example already discussed, a confidentiality agreement. In that case, the confidential information is the consideration given by the employer. Providing confidential information to the employee “gives rise to” the employer’s interest in restraining competition, at least where the employee could use the confidential information to compete. See id. at 647 n.14.

Personally, I think Light got this point exactly right. “Ancillary,” in this context, has to mean something more than just related. The non-compete will always be related to some benefit provided to the employee; otherwise, it would be void for lack of consideration under basic contract law principles.

But Texas employers didn’t like this “give rise to” requirement. Yes, this requirement was fairly easy to apply in the typical case where the non-compete was tied to a confidentiality agreement, but in other contexts it presented more of a problem. For example, suppose an employer requires a non-compete as part of an agreement to provide stock options to a trusted executive. It’s hard to see how the stock options “give rise to” an interest in restraining the executive from competing.

Put it this way: Does competition from an executive who has stock options do more damage than competition from a former executive who doesn’t have stock options? I don’t think so.

Still, businesses don’t want employees with stock options to compete, and the Texas Supreme Court likes businesses, so the court jettisoned Light’s “give rise to” requirement in Marsh USA Inc. v. Cook, 354 S.W.3d 764, 773-76 (Tex. 2011). Instead of requiring the consideration to “give rise to” the employer’s interest in restraining competition, Marsh held that it is sufficient for the consideration to be “reasonably related” to an interest worthy of protection, such as confidential information or goodwill. Id. at 775. Applying this new “reasonably related” test, Marsh held that stock options were reasonably related to the protection of goodwill. Id. at 777.

“Reasonably related” is pretty weak sauce. Personally, I think getting rid of the “give rise to” requirement was a mistake, for reasons already covered. Plus, the majority opinion in Marsh is heavy on economic theory and light on practical experience. (For a look at how non-competes actually work in practice, see The Problem With Non-Competes.)

But I’ll bet most lawyers applauded Marsh, because applying the “give rise to” requirement outside the typical confidentiality agreement scenario was such a headache. And I will give Marsh its due: it at least had the benefit of making the “ancillary” requirement simpler to apply.

Still, Marsh did not completely extinguish Light.

The “designed to enforce” requirement

Remember, Light also said “the covenant must be designed to enforce the employee’s consideration or return promise in the otherwise enforceable agreement.” In the typical case where the non-compete is tied to a confidentiality agreement, the non-compete meets this requirement because it is designed to enforce the employee’s promise not to use or disclose the employer’s confidential information. At least, that’s the theory.

So, in the typical case involving a confidentiality agreement, Light’s “designed to enforce” requirement will usually be satisfied.

But what about other types of “otherwise enforceable agreements”? Do they still have to meet Light’s “designed to enforce” requirement? Or did Marsh abolish that requirement too?

That was the issue in Titan Oil & Gas Consultants, LLC v. Willis, No. 06-20-00026-CV, 2020 WL 6878418 (Tex. App.—Texarkana Nov. 24, 2020, no pet. h.). In Titan, the employer argued that Marsh overruled Light’s “designed to enforce” requirement, but the Court of Appeals disagreed. Marsh specifically stated that it was only addressing the “give rise to” prong of Light, the Titan court said, not the “designed to enforce” prong. Id. at *5.

The Court of Appeals was therefore bound to follow the “designed to enforce” requirement. “Neither Marsh nor any other Texas Supreme Court that has considered Light has overruled Light’s designed-to-enforce element of an enforceable covenant not to compete,” the court said. And it is not the function of a court of appeals to abrogate or modify Texas Supreme Court precedent. Id. at *6.

So, Light’s “designed to enforce” requirement survives. For now.

Does the requirement make any practical difference? It did in Titan, but the circumstances there were unusual. The employee signed a contract with one company, Titan, but received the confidential information from a different company, Apache, and the non-compete only restricted the employee from working for Apache. The court reasoned that a restriction on working for Apache was not designed to enforce the employee’s promise not to disclose Apache’s confidential information. Id. at *6.            

Outside of oddball situations like Titan, the “designed to enforce” requirement probably doesn’t do much for the employee. But lawyers in Texas non-compete cases should at least be aware of the requirement and consider whether the contract meets it.

______________________________

Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation. Thomson Reuters named him a 2020 Texas “Super Lawyer”® for Business Litigation. This post is dedicated to Bob Schneider.

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.

The Most Common–and Easily Fixable–Mistake in Texas Noncompete Litigation

The Most Common–and Easily Fixable–Mistake in Texas Noncompete Litigation

I made a big mistake last Friday. I opened my Twitter feed before watching the season finale of The Mandalorian with my kids. Y’all can guess what happened.

Speaking of spoilers, here’s a SPOILER ALERT: If you would rather learn for yourself the most common and easily fixable mistake in Texas non-compete litigation, I recommend first litigating a bunch of non-compete cases in Texas and getting them wrong. But if you just want the answer, read on.

And if you’ve watched my YouTube video The Reasonable Time Period Requirement for a Texas Non-Compete, you probably already know the answer.

As that video hints, the most common and easily fixable mistake lawyers make in Texas non-compete litigation is failing to offer evidence—not just argument—regarding the reasonableness of the non-compete’s time period.

Fortunately, this is easily corrected. Just offer testimony from your client explaining why the time period is or is not longer than necessary to protect the company’s confidential information and/or goodwill with customers (depending on which side you’re on). And make sure the testimony is specific, not conclusory.

Even better, offer expert testimony on this issue. In most cases, your client or client representative probably has enough experience in the industry to qualify as an expert, so you won’t need to hire one. For example, if you represent a former employee who has a two-year non-compete, offer expert testimony that the employer’s confidential information becomes stale within a year, or that goodwill with customers is likely to dissipate in a year.

This is sure to draw an objection, but if the witness has significant experience in the industry and gives specific reasons for the opinion, what’s the objection?

You may also draw an objection that reasonableness is a question of law, but that’s wrong (sort of), as I explained in Blown Call: The Thing Texas Courts Get Wrong About Non-Competes.

Anyway, fact or opinion testimony should, at a minimum, create a fact issue regarding the reasonableness of the time period, and thus, the enforceability of the non-compete.

And yet, lawyers in Texas non-compete litigation hardly ever do this.

(Reminder: This is not legal advice for your case. Every case is different, and there may be valid strategic reasons not to offer such evidence in a particular case.)

I’ve handled a lot of non-compete disputes, and in my experience, lawyers on both sides rarely offer evidence about the reasonableness of the non-compete’s time period. And expert testimony on the issue is even more rare.

Most of the time, reasonableness of the time period is an afterthought. At most, the lawyers will offer argument about it, rather than evidence, and cite a few cases.

Why is that?

Let’s back up a bit to put this problem in context.

Enforceability is almost always a key issue in a non-compete lawsuit. In the typical case where an employer sues a former employee to enforce a non-compete, the employer has the burden to prove that the non-compete is enforceable. See Tex. Bus. & Com. Code § 15.51(b). That includes proving that the non-compete is reasonable in time period, geographic area, and scope of activity restrained. Tex. Bus. & Com. Code § 15.50(a).

One caveat: in a temporary injunction hearing, it is debatable whether the judge should address enforceability of the non-compete. On the one hand, likelihood of success on the merits is one of the elements required for a temporary injunction. See, e.g., Tom James of Dallas, Inc. v. Cobb, 109 S.W.3d 877, 884 (Tex. App.—Dallas 2003, no pet.).  On the other hand, the court does not decide the “ultimate issue” of enforceability at the temporary injunction stage. Id.

Let’s put that complication aside and assume that enforceability of the non-compete is somehow an issue before the court, whether it’s a TCPA motion to dismiss, a temporary injunction, a summary judgment motion, or at trial.

In that case, the employer needs to offer evidence that the time period is reasonable. Otherwise, the court may rule that the employer failed to meet its burden of proof. And if you represent the employee, you should offer evidence that the time period is unreasonable, even if you don’t have the burden of proof.

So, for example, even if the time period is only one year, evidence that one year is longer than necessary to protect the employer’s confidential information or goodwill may be enough to prove that the non-compete is unenforceable.

That’s what happened in CDX Holdings, Inc. v. Heddon, No. 3:12-CV-126-N, 2012 WL 11019355 (N.D. Tex. March 2, 2012). In that case, the court held that the plaintiffs failed to meet their burden to show one-year limitation was reasonable, where there was testimony that the information was confidential and would be valuable to competitors, but there was also testimony that the information was “continually changing and updated” and had a “short shelf life.” Id. at *9.

I don’t know if that was the right factual determination, but the approach in CDX Holdings was correct. The court should look at the evidence to decide whether the time period is reasonable.

That is not what usually happens. Here’s the typical scenario. The time period of the non-compete will be less than five years. The employer’s counsel will cite Texas cases for the “Five-Year Rule,” which says that Texas courts have repeatedly upheld non-competes with time periods of two to five years. The employee’s counsel will then make some argument—but not offer any evidence—that this case is different for some reason. In most cases, if the issue goes up on appeal, the Court of Appeals will cite the Five-Year Rule and say the time period was reasonable.

Funny thing about the Five-Year Rule, though: when you investigate its origins, you find that the first Texas case that cited it basically just made it up. I explained this in What is a Reasonable Time Period for a Texas Non-Compete? But the rule has now been repeated so many times that it has become a sort of self-fulfilling prophecy.

Here’s another funny thing about the Five-Year Rule: if you look at the opinions that cite it, very few—if any—are cases where there was conflicting evidence about the reasonableness of the time period. (Or if there was conflicting evidence, the opinion ignores it.)

Let’s look at a recent example.

In Reilly v. Premier Polymers, LLC, No. 14-19-00336-CV, 2020 WL 7074253, at *1-2 (Tex. App.—Houston [14th Dist.] Dec. 3, 2020, no pet. h.) (mem. op.), a commodity polymers company sued a former sales manager and his new employer, claiming breach of contract, tortious interference, and misappropriation of trade secrets. The court held that the 18-month period of the manager’s non-solicitation covenant was reasonable, citing the usual suspects for the Five-Year Rule. Id. at *10-11.

Curiously, the opinion did not cite any evidence from the record about whether 18 months was longer than necessary to protect the employer’s confidential information, goodwill, or other business interest.

So I looked at the Appellants’ Brief (at pp. 41-43) and the Appellee’s Brief (at pp. 35-36) to see if the parties cited any evidence about whether 18 months was reasonable. Nope.

Instead, the defendants argued that the 18-month period was punitive, and therefore unreasonable, because the agreement also provided that employees terminated for reasons other than for “cause” were only subject to a one-year non-solicitation restriction. 2020 WL 7074253 at *11. In effect, the agreement imposed an additional six months of non-solicitation as a punishment for employees who quit, the defendants argued.

That sounds like a plausible argument to me, but the defendants cited no case law to support it, and the plaintiff attacked it as a “made-up rule.” The Court of Appeals sided with the plaintiff, declining to adopt the defendants’ proposed standard, “particularly where the 18-month period at issue is well-within what other courts have deemed reasonable.” Id.

Thus, as in most Texas non-compete lawsuits, it appears neither side offered any evidence about whether 18 months was longer than necessary, and the Court of Appeals decided the case based purely on argument and case law, without considering any evidence in the record.

But what if the defendants had offered evidence?

Let’s say Reilly, who worked as a salesperson and regional manager for the polymers company for seven years, testified as an expert that a one-year non-solicitation covenant would be sufficient to protect the company’s confidential information (if any) and customer goodwill, giving specific reasons based on his familiarity with the company, its customers, and the industry. Would that have been sufficient evidence that 18 months was unreasonable, and the restriction therefore unenforceable?

We may never know, but you should try it. This is the way.

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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. 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.

What Is a Reasonable Time Period for a Texas Non-Compete?

What Is a Reasonable Time Period for a Texas Non-Compete?

Baseball legend Yogi Berra reportedly said “I usually take a two-hour nap from one to four.” He also said “the future ain’t what it used to be.” Obviously the guy had a unique sense of time.

Time is on my mind because of this week’s blog topic: What is a reasonable time period for a Texas non-compete?

For almost a century, Texas case law has required that a non-compete be limited to a reasonable time period, and in 1989 the legislature codified this requirement in the Texas Covenants Not to Compete Act. The time period must be no longer than necessary to protect the employer’s goodwill or other business interest (usually confidential information). See Tex. Bus. & Com. Code § 15.50(a). And in the typical context of an employment contract, the burden is on the employer to prove the time period is reasonable. See Tex. Bus. & Com. Code § 15.51(b).

The time period of a Texas non-compete must be reasonable. That much is clear. But what does “reasonable” mean in practice? Is there any rule we can discern from the decades of case law?

Unfortunately, the Texas case law applying the reasonable time period is remarkably unsatisfying. You’re just not going to find much analysis defining what makes a time period reasonable or not. The best I can do to synthesize a “rule” from the cases is the “Five-Year Rule.”

The Five-Year Rule says that when addressing the reasonable time period requirement, the court will declare that Texas cases have upheld non-competes of two to five years, and if the time period at issue is five years or less, the court will then find the time period reasonable, without discussing any specific evidence.

I don’t find the Five-Year Rule very helpful or persuasive. As the statute indicates, the question is whether a shorter time period would be sufficient to protect the interest at issue, which is usually the employer’s confidential information and/or goodwill.

I propose an alternate rule, the Wolfe Rule. The Wolfe Rule says that when there is conflicting evidence about whether the time period of a non-compete is reasonable, it presents a fact issue for the jury.

Now, you’re not going to find the Wolfe Rule stated explicitly in any Texas cases, but it is the correct rule. I would even go as far as saying it is obviously the correct rule, and the fact that Texas courts have not expressly stated it presents something of a mystery. And one more thing: the Wolfe Rule does not necessarily conflict with the Five-Year Rule.

How can all of this be true?

To understand, first we need some historical perspective.

We’ll start in the Ice Age. I call it that because you could write the early history of Texas non-compete law based on cases involving the ice delivery business. I wrote about one of these cases, City Ice Delivery Co. v. Evans, 275 S.W. 88 (Tex. App.—Dallas 1925, no writ), in Jurassic Non-Competes.

There were at least four more Texas non-compete cases about ice delivery in the 1920s alone. Oak Cliff Ice Delivery Co. v. Peterson, 300 S.W. 107 (Tex. Civ. App.—Dallas 1927, no writ); Carpenter v. Southern Properties, Inc., 299 S.W. 440 (Tex. Civ. App.—Dallas 1927, writ ref’d); Texas Ice & Cold Storage Co. v. McGoldrick, 284 S.W.615 (Tex. Civ. App.—San Antonio 1926, writ ref’d); Bettinger v. North Fort Worth Ice Co., 278 S.W. 466 (Tex. Civ. App.—Fort Worth 1925, no writ).  

You can find in these cases many of the principles that still apply in Texas non-compete law today, including the requirement that the non-compete must have a reasonable time period. For example, in Carpenter v. Southern Properties the court said a non-compete can only prohibit competition “for a reasonable space of time” after employment, and the employer has the burden to prove that the non-compete is reasonable “in its duration of time.” 299 S.W. at 443.

The non-compete in Carpenter had a two-year time period. Id. at 442. Was this reasonable? “[T]he trial court has found that the negative covenant sought to be enforced was both reasonable and necessary,” the court said, “and we are not prepared to say that there is not substantial evidence sustaining such finding.” Id. at 444.

That was it. Nothing about what the evidence regarding the time period was. Nothing about why the evidence established that two years was reasonable. And the depth of analysis of the reasonable time period requirement in the next century of Texas case law would not significantly improve.

By 1960, it was well established that a non-compete should be limited “for such a time as is reasonably necessary to protect the employer’s business and good will,” and that the “burden of proof is on the former employer” to establish “by satisfactory evidence” the reasonableness of the non-compete. Weber v. Hesse Envelope Co., 342 S.W.2d 652, 654-55 (Tex. Civ. App.—Dallas 1960, no writ).

And by that time Texas courts had moved from ice delivery to a more fascinating business: envelope sales. Yes, Weber was about a two-year non-compete signed by an envelope salesman. No word on whether Weber also owned a beet farm.

This battle in the great Metroplex envelope wars was tried to the bench, the salesman was the only witness, and the trial court declared the non-compete enforceable. Id. at 653. As to the two-year time period, the Court of Appeals said only that there was “ample support in the evidence” for the trial court’s implied finding that the two-year period of the non-compete was reasonable. Id. at 655.

That was it. The court didn’t cite any of the “ample” evidence or explain how the evidence established that two years was reasonable.

Are you detecting a pattern?

About 20 years later, the superficial treatment of the reasonable time period requirement got worse in AMF Tuboscope v. McBryde, 618 S.W.2d 105 (Tex. App.—Corpus Christi 1981, writ ref’d n.r.e.). That case addressed another two-year non-compete, this one involving the oilfield pipe inspection business. On an application for temporary injunction, the trial court found the time period unreasonable. Id. at 108.

The Corpus Christi Court of Appeals disagreed. The court did not cite any evidence from the record on the reasonableness of the time period, but it stated that the employees had cited no case authority for the proposition that two years is unreasonable. Id. The court then declared: “Two to five years has repeatedly been held a reasonable time in a noncompetition agreement.” Id.

This appears to be the earliest statement of the Five-Year Rule.

AMF Tuboscope cited three cases in support of the Five-Year Rule, but curiously, none of those cases supported the rule:

  • In Arevalo v. Velvet Door, Inc., 508 S.W.2d 184, 185 (Tex. Civ. App.—El Paso 1974, writ ref’d n.r.e.), there was a three-year non-compete but “no contention that the time or space limitation is unreasonable.”
  • In Electronic Data Systems Corp. v. Powell, 508 S.W.2d 137, 138-40 (Tex. Civ. App.—Dallas 1974, writ ref’d n.r.e.), the court upheld the limited scope of the trial court’s temporary injunction. The non-compete at issue had a three-year period, but the reasonableness of that time period was not one of the issues raised in the case.
  • As we have seen, in Weber v. Hesse Envelope, the court said there was ample evidence to support finding the two-year period reasonable, but the opinion said nothing about five years.

You read that right. None of these cases involved a five-year non-compete. And only one of them even addressed whether the time period at issue was reasonable.

So, while I hate to be harsh, the fact is, the statement of the Five-Year Rule in AMF Tuboscope was at best inaccurate, and at worst dishonest.

Almost 30 years later, the Houston Court of Appeals repeated this error verbatim in Gallagher Healthcare Insurance Services v. Vogelsang, 312 S.W.3d 640 (Tex. App.—Houston [1st Dist.] 2009, pet. denied), a case involving a two-year non-compete in the insurance brokerage business. The trial court granted summary judgment that the non-compete was unenforceable, but the Court of Appeals reversed. Id. at 642-43.

Gallagher reasoned that the two-year period was “not unreasonable” because the evidence showed that insurance contracts lasted for a year. Id. at 655. That at least reflected some analysis based on the evidence.

But then the court declared, “Two to five years has repeatedly been held as a reasonable time in a noncompetition agreement,” citing the same three cases cited in AMF Tuboscope. Id.

Thus, not only did Gallagher repeat the same error made in AMF Tuboscope, it did so while addressing a two-year non-compete.

But once the Five-Year Rule was expressly stated in at least two opinions, Texas courts started to invoke it almost routinely, and not just for two-year non-competes.

For example, in Salas v. Chris Christensen Systems, Inc., No. 10-11-00107-CV, 2011 WL 4089999 (Tex. App.—Waco Sept. 14, 2011, no pet.), the court considered the reasonableness of a five-year non-compete in the dog grooming products industry.

Salas did not cite any evidence about the reasonableness of the time period. Instead, it simply said “Texas courts have held that two to five years is a reasonable time restriction in a non-competition agreement,” citing Gallagher and the same three cases cited by Gallagher and AMF Tuboscope. Id. at *19. “Given this,” the court said, “we cannot say that the Agreement’s five-year restraint is per se unreasonable.” Id.

This, of course, misstated the issue. The question should have been whether the employer met its burden to prove that the five-year period was reasonable, not whether a five-year period was “per se” unreasonable.

But the damage has been done. Since Salas, both state and federal courts in Texas have continued to cite the Five-Year Rule, even when the non-compete at issue has a time period of just one or two years:

All of these cases cite the Five-Year Rule uncritically, perhaps without realizing that AMF Tuboscope pretty much just made up the rule, almost 40 years ago.

But in a sense, the Five-Year Rule has become a self-fulfilling prophecy. Now that so many Texas courts have cited and applied it, it has effectively become true.

So that solves the mystery of how Texas courts came to adopt the Five-Year Rule, at least in part.

But is it the right rule?

I’ll cover that in Part 2. It ain’t over til it’s over.

__________________________

Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation. 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.

Drafting the Bullet-Proof Non-Compete: Part 3

Drafting the Bullet-Proof Non-Compete: Part 3

This series has focused on drafting an enforceable Texas non-compete, because that’s where I practice, but if you’re drafting a non-compete for a company in the oil and gas industry, you may need to consider other states, especially Louisiana. Check out Drafting Enforceable Non-Competes in the Energy Industry for some good tips.

But back to Texas.

In Part 1 we saw how to draft a Texas non-compete to meet the once-elusive “ancillary to an otherwise enforceable agreement” requirement.

In Part 2 we saw how to meet the “reasonableness” requirement.

You could stop there and have a pretty decent Texas non-compete, but do you need a separate non-solicitation agreement? And what about all that additional boilerplate you often see in non-competes? Do you need that?

I’ll answer those questions in this third and final installment.

10. Does the agreement need to restrict both competition and solicitation?

This is kind of a trick question, because a restriction on soliciting customers is a restriction on competition. See Is a Non-Solicitation Agreement a Non-Compete? In other words, a “non-solicit” is subject to the same statutory requirements as a “non-compete,” at least in Texas.

Still, many non-competes have one section for restrictions on competition and another section restricting solicitation. This format is often unnecessarily duplicative. I think it is simpler to combine the two in one section.

But the substantive question remains, should the agreement restrict competition generally and solicitation specifically?

There is a case to be made for restricting competition and not getting into the messier issue of solicitation. The problem with a restriction on solicitation is that it almost always leads to factual disputes.

Suppose Dawn Davis leaves her sales position at Paula Payne Windows and goes to work for Real Cheap Windows. The next week, her friend and customer Bob Builder calls her up:

“Hey Dawn, how’s it going?”

“Pretty good, Bob, it’s been a busy week.”

“Oh really?”

 “Yeah, you may not have heard yet, but I left Paula Payne and went to Real Cheap.”

“Wow, I didn’t know that.”

“Well, Bob, I really like the value they provide for their customers.”

“That’s great. You know, I was going to order some more storm windows for that new subdivision project, can Real Cheap give me a good price on those?”

Did Dawn just “solicit” business from Bob? Would it make a difference if Dawn had made the call to Bob, just to chat? Would it make a difference if Dawn had not volunteered that she changed companies?

You can see how “solicitation” creates questions and uncertainty.

In contrast, it’s pretty easy to determine if an employee violates a restriction on “doing business” with a certain customer. If Dawn goes to Real Cheap and Bob then starts buying windows from Real Cheap, that’s “doing business.” We don’t have to get into the whole “solicitation” issue.

Given the kind of factual disputes that often come up, I don’t use the word “solicit” in my form. But I do include a restriction on “urging or causing” a customer to become a customer of the new company.

That, of course, does not entirely solve the problem, because you could have the same kind of factual disputes about “urging” or “causing.” But I think those terms are easier to apply than “soliciting.”

And I think there is some advantage to including a restriction on “urging or causing” in addition to the more general restriction on “doing business.”

11. Should the non-compete state that it is an “independent covenant”?

Yes. The employee will sometimes argue that she is excused from complying with the non-compete because the employer breached the employment agreement first.

To avoid or at least reduce the risk of this argument being successful, I include this clause in my form:

Even without such a clause, the employer could argue that the non-compete is an independent covenant because the employer’s breach of another clause—such as the obligation to pay a bonus or commission—could be separately compensated by damages. But expressly stating the parties’ intent to treat the non-compete as an independent covenant should remove any doubt. See Chambers v. Hunt Petroleum Corp., 320 S.W.3d 578, 584 (Tex. App.—Tyler 2010, no pet.) (clause should be treated as an independent covenant if “a breach may be compensated for in damages . . . unless this is contrary to the expressed intent of the parties”) (citing Centex Corp. v. Dalton, 840 S.W.2d 952, 956 (Tex.1992)). 

12. Should you have the employee stipulate that the non-compete is reasonable and can be reformed?

This is probably ineffective and unnecessary, but it doesn’t hurt, and it may carry some weight with a judge who is not sophisticated about non-competes.

Most non-competes contain some kind of stipulation that the restrictions are reasonable. In my personal opinion, courts should give these stipulations no weight, especially considering limitations on non-competes are a matter of public policy. But some judges might give some weight to the stipulation, and you might be able to use the stipulation to get the employee to admit the scope of the non-compete is reasonable.

It also doesn’t hurt to include a reformation and severability clause. This is probably unnecessary, because the Texas statute already says the court shall reform an overbroad non-compete. But again, it doesn’t hurt to include it.

So, my form includes the following:

13. Should the non-compete include an “ipso facto” clause granting an injunction?

This is a close call for me. Most non-competes contain stipulations designed to support the employer’s request for an injunction. I call this an “ipso facto” clause. Texas courts vary on whether an ipso facto clause has any effect. See Can a Non-Compete Grant an Injunction by Stipulation?

Personally, I don’t give any weight to a non-compete ipso facto clause. But not everybody agrees with me, and it probably doesn’t hurt to include one. Mine looks like this:

Again, my own view is that this kind of stipulation should have no legal effect, but if the non-compete has an ipso facto clause, I might cite it as at least one of my grounds for an injunction.

14. Should the non-compete include “non-circumvention” language?

Employees often try to “get around” non-competes. “Technically I’m not competing with my former employer,” you can imagine an employee arguing, “I’m just providing consulting services to an LLC that my cousin owns.”

That’s just one example, but you get the idea.

This kind of gambit to circumvent a non-compete is usually not persuasive. If the judge applies the plain, common-sense meaning of the non-compete, this type of argument by the employee should usually fail.

But of course judges don’t always do that, and in fairness to the employee, if the employer drafts the non-compete poorly and its plain language does not prohibit the thing the employee is doing, then that’s the employer’s problem. See, e.g., East Texas Copy Sys., Inc. v. Player, 528 S.W.3d 562, 567-68 (Tex. App.—Texarkana 2016, no pet.) (enforcing plain meaning that allowed employee to avoid non-compete by terminating his own employment without cause).

I try to head off any cleverly contrived arguments by the employee by including the following in my form:

The idea is to avoid any hyper-technical interpretation intended to get around the non-compete. I haven’t had occasion to test it in court yet, but I would rather have it than not.

15. Should the non-compete prohibit making plans to compete?

Hey, why not? My form includes the following:

This is something I came up with that, somewhat surprisingly, I have not seen in other non-competes.

It is common for an employee to make plans to compete while still employed by the employer. And Texas courts have said that making such plans—and even concealing them from the employer—is not a breach of the employee’s quasi-fiduciary duty to the employer. See Fiduciary Duty Lite: What Employees Can and Can’t Do Before Leaving.

The rationale of the employee fiduciary duty cases is employee mobility. But those cases don’t necessarily stop the employer from creating a contractual duty not to make plans or preparations to compete. So I include that commitment in my form.

It’s such a clever idea, I almost feel guilty.

Like I said at the start, I don’t even like non-competes. I think most employers would be better off focusing on keeping their best employees happy, rather than trying to keep their employees from running off with customers. See The Most Effective Form of Non-Compete in Texas (or Anywhere).            

But if you’re going to make an employee sign a non-compete, you might as well draft it as effectively as possible.

______________________________________

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

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

Drafting the Bullet-Proof Non-Compete: Part 2

Drafting the Bullet-Proof Non-Compete: Part 2

I decided to share my updated Plain-Language Non-Compete with the world, and not only that, I’m walking you through it step by step to explain why I drafted it the way I did.

In Part 1 we learned:

  1. You should draft a non-compete in a style and format that is easy to read and present in the courtroom.
  2. The non-compete should expressly state that the company will give the employee confidential information.
  3. The non-compete should provide for giving the employee specialized training, if applicable.
  4. The non-compete doesn’t need a complicated definition of competing.

Next we get into the real heart of making a non-compete as enforceable as possible: reasonableness.

You probably already know that Texas law requires a non-compete to be reasonable in time period, geographic area, and scope of activity. But do you know how to draft the non-compete to meet this requirement?

Don’t worry, we’ve got you covered.

5. Should the non-compete have a reasonable time limitation?

Yes. This is a no-brainer. The statute requires it, Tex. Bus. & Com. Code § 15.50(a), and a non-compete with no time limitation is therefore unenforceable on its face. 

But what should the time limitation be? This is harder, and there’s no one-size-fits-all answer.

If the non-compete is part of the sale of a business, Texas courts are likely to allow a longer time period. See Oliver v. Rogers, 976 S.W.2d 792, 801 (Tex. App.—Houston [1st Dist.] 1998, pet. denied) (lack of time limitation did not render non-compete unreasonable when it was part of the sale of a business).

So for the sale of a business, I would recommend something in the range of three to five years.

But for the typical employee non-compete, shorter is better. Your maxim should be “shorten it until it hurts.” When the length of time is short enough that it causes the client some discomfort, you’re probably getting it right.

As a rule of thumb, I say the typical employee non-compete should be limited to one year. Two years max.

Yes, there are Texas cases that find periods of as long as five years reasonable. See Stone v. Griffin Comms. & Security Sys., Inc., 53 S.W.3d 687, 696 (Tex. App.—Tyler 2001, no writ) (“two to five years has repeatedly been held a reasonable time restriction in a non-competition agreement”) (citing cases).

But the analysis in those cases is superficial. I say go shorter, for several reasons.

First, keep in mind that if a court finds the time period as written is unreasonably long, then this effectively cuts off the employer’s right to get damages for breach of the non-compete. See Tex. Bus. & Com. Code § 15.51(c). The employer can still seek an injunction, but the right to get damages is a significant bargaining chip.

Second, the employer usually has the burden to prove the time period is reasonable. If I’m representing the employee, I guarantee you I am going to try to take advantage of this. If I see a time period of two years or more, that gives me something to attack. I can almost always offer testimony from my client that at least creates a fact issue about whether the time period is reasonable.

One year, on the other hand, is pretty hard to attack. I’m not saying you could never prove that one year is longer than needed, but in most cases that’s going to be a tough sell.

Finally, one year is usually enough to accomplish your client’s key business goal: stop a departing employee from immediately moving her key customers to her new company. The first few months are usually critical. In most cases, one year should be enough time for the company to try to persuade the key customers to stay.

6. Should the time period have a “tolling” clause?

I don’t recommend it.

A tolling provision extends the time period of the non-compete by the time that the employee was violating the non-compete. So, for example, if an employee competes for six months before a court enters an injunction to stop the competition, the time period of the non-compete would be extended by six months.

The upside to the employer is obvious. The downside is that it gives the employee an argument that the time period is indefinite and unenforceable. See Central States Logistics, Inc. v. BOC Trucking, LLC, 573 S.W.3d 269, 277 (Tex. App.—Houston [1st Dist.] 2018, pet. denied) (citing Cardinal Personnel, Inc. v. Schneider, 544 S.W.2d 845 (Tex. App.—Houston [14th Dist.] 1976, no writ)).

I wouldn’t say the issue is totally settled under Texas law, so you can include a tolling clause if you really want to, but why complicate the time period unnecessarily?

Simpler = easier to enforce.

7. Should the non-compete have a reasonable geographic limitation?

Duh. Of course it should. The requirement is right there in the statute. Tex. Bus. & Com. Code § 15.50(a).

But believe it or not, I still sometimes see non-competes with no geographic limitation. How can this happen?

To be fair, there are Texas cases that say a limitation on scope of activity can be used in lieu of a geographic limitation, especially where the employee is a high-level executive who is responsible for the company’s operations everywhere, or where customer goodwill is not tied to any specific geographic area. I cover this is in Geographic Area of a Texas Non-Compete – Part 2.

Still, why chance it? Even if you need to make the geographic area extremely broad, it’s still better to have some geographic limitation than none.

But what should it be?

8. What should the geographic limitation be?

In general, the geographic limitation should coincide with the expected area the employee will be responsible for.

For sales employees, that usually means the employee’s sales territory. I call this the Sales Territory Principle. See Geographic Area of a Texas Non-Compete – Part 1.

It gets more complicated with upper-level management. But even for higher-level executives, I think you should try to define the geographic area they will be responsible for, even if that means a geographic limitation like “the United States,” “North America” or “the US Gulf Coast.”

My form geographic limitation looks like this:

It doesn’t have any more specific formula, but for geographic area there’s just no way to get around the need to adapt the clause to fit the circumstances.

9. Should the non-compete have a reasonable limitation on scope of activity?

Yes. Again, the Texas non-compete statute requires this.

But this is probably the most neglected requirement of the statute. I often see non-competes that define the restricted scope of activity too broadly.

Can you keep a secret? If I represent the employee, this gives me the argument that the non-compete is a prohibited “industry-wide exclusion.” See Burning Down the Haas: The Industry-Wide Exclusion Rule in Texas Non-Compete Law.

This is the most common defensive argument I make for employees. For a typical sales employee, if the non-compete is not limited to the customers the employee dealt with at the company, I will argue it is unreasonably broad.

On the other hand, Texas cases tend to allow restricting a broader scope of activity where the employee is a high-level executive who is responsible for the whole company, not one subset of customers.

So my non-compete form provides two options, depending on the type of employee:

Option 1 may strike some employers as too narrow. But again, the advantage is that it will be difficult for the employee to argue that the scope of activity is too broad. That’s a significant tactical advantage for the employer in a non-compete lawsuit. And from a business perspective, it focuses on the key customers that the company if probably most concerned about the employee taking.

Option 2 is broader, because it is not limited to particular customers, but note that it is still limited to customers or prospects. This is usually better than prohibiting competition with the company generally, which could be seen as a prohibited industry-wide exclusion.

I was on the fence about including “prospects” in Option 2. If you really want to make your enforceability argument strong, you could take that out.

Also note that I use the phrase “doing business” rather than some longer formulation. I think “doing business” has a common-sense plain meaning that is usually easy to understand. If the employee’s lawyer wants to try to argue that providing goods or services for money is somehow not “doing business,” good luck with that.

Beyond Reasonableness

Now you know how to draft the non-compete to be reasonable. That is the most important part of enforceability.

But what else can you include in the non-compete to make sure it is effective and enforceable? Does it need a separate restriction on solicitation of customers? Should it include a lot of self-serving boilerplate in the event of a lawsuit?

I’ll tackle those questions in Part 3.

_______________________________________________

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

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

Drafting the Bullet-Proof Texas Non-Compete: Part 1

Drafting the Bullet-Proof Texas Non-Compete: Part 1

So you want a bullet-proof Texas non-compete.

Well, don’t we all. But of course, there is no such thing. The basic principle of non-compete law is reasonableness, and that’s a pretty fuzzy concept. So no matter how well the non-compete is drafted, there will almost always be some argument that it is unreasonable.

Still, there are ways to draft a non-compete to maximize the chance that a court will enforce it later.

I’m a little reluctant to share these tips. For one thing, I don’t really like non-competes. But sometimes my clients want me to draft one or enforce one, and like they say in the Fabulous Baker Boys, if the money’s green . . .

So I do have a form non-compete I use. You can download it here if you want. *Disclaimer: every situation is different, and you should not use this form without being or consulting with a lawyer.

And here are the key questions that come up when you’re drafting a typical Texas non-compete.

1. Should you draft the non-compete in a style and format that is easy to read and to present in the courtroom?

The question pretty much answers itself, doesn’t it?

And yet . . . most non-competes are written in a format that is difficult to read.

When it comes to style, lawyers who draft non-competes tend to go wrong in several ways:

  • Long, dense paragraphs
  • Each clause written as a single lengthy sentence
  • Small type
  • Unappealing fonts
  • No paragraph breaks between items in a list
  • Really long lists
  • Too much ALL CAPS
  • No Oxford commas (an almost unforgivable sin)
  • Too many acronyms or abbreviations
  • Too much legalese

I’ve seen a lot of non-competes that commit one or more of these offenses.

But one might object, what difference does the style make if the substance is good?

I addressed this in The Plain-Language Non-Compete. In short, if you want to maximize the enforceability of a non-compete in the courtroom, you will make it as readable and presentable as you can.

So, I now use 12-point Century Schoolbook. Not too stuffy, but not too modern. It’s not going to win any typeface awards or anything, but it’s less generic than Times New Roman. You can probably find a better font that suits your style.

I use bold headings, but not in all caps, and I now indent my paragraphs. When I use a list, I have a paragraph break after each item in the list. I use fairly standard margins.

You might decide to make different decisions regarding style and format, and that’s fine. You can probably come up with something better than I have. The point is to pay attention to these style issues.

Now let’s get into substance.

2. Should the non-compete expressly state that the company will give the employee confidential information?

The answer is yes.

The first thing any Texas non-compete with an employee should do is expressly state that the company agrees to provide the employee with confidential information. This is the simplest way to meet the requirement that a Texas non-compete must be “ancillary to an otherwise enforceable agreement.” Tex. Bus. & Com. Code § 15.50(a); Alex Sheshunoff Mgmt. Servs., L.P. v. Johnson, 209 S.W.3d 644, 655 (Tex. 2006).

I will sometimes see a confidentiality clause stating that the employee will not disclose the company’s confidential information, but never expressly promising to give the employee confidential information.

That’s better than nothing, and it may be sufficient to create an implied promise to provide the employee confidential information. See Mann Frankfort Stein & Lipp Advisors, Inc. v. Fielding, 289 S.W.3d 844, 850 (Tex. 2009).

But why chance it? There’s no good reason not to include an express promise. So, the first part of my form non-compete looks like this:

As you can see, my form has two options, depending on whether the employee is a new hire or is being promoted.

Having an employee sign a non-compete midstream is tricky. If the company doesn’t provide some new consideration for the non-compete, then the employee can argue later that the non-compete is void for lack of consideration.

The obvious candidate for consideration is continued employment. But the promise of continued at-will employment may be considered illusory and therefore not real consideration. See J.M. Davidson, Inc. v. Webster, 128 S.W.3d 223, 228 (Tex. 2003) (at-will employment does not preclude providing contract formation “so long as neither party relies on continued employment as consideration”); Eurecat US, Inc. v. Marklund, 527 S.W.3d 367, 389 (Tex. App.—Houston [14th Dist.] 2017, no pet.) (“a promise of continued [at-will] employment is illusory and does not constitute consideration”). But see Arevalo v. Velvet Door, Inc., 508 S.W.2d 184, 186 (Tex. Civ. App.–El Paso 1974, writ ref’d n.r.e.) (“continuation of employment with payment of salary is consideration for a restrictive covenant not to compete”) (citing cases).

So, the employer needs to provide some kind of consideration other than just continued employment.

Continued access to the company’s confidential information may be sufficient, provided the company actually provides it. But if the company merely continues to provide the same kind of information as before, the employee can argue there was no new consideration.

The better thing to do, when feasible, is to tie the non-compete to a promotion that gives the employee access to a wider scope of confidential information than before. That’s why my form for a post-promotion non-compete says “we will also give you new types of confidential information that you did not have access to in your previous position.”

There could still be a factual dispute about whether this actually happened. But if the company includes this language, it will at least have a reasonable argument that it agreed to provide new consideration for the non-compete, and that the non-compete was ancillary to that agreement.

3. Does the non-compete need to provide for specialized training?

Specialized training is the Dickey Betts of Texas non-competes. Less well known than confidential information, but just as effective.

Including a promise to provide specialized training is another way to meet the requirement that a Texas non-compete must be “ancillary to an otherwise enforceable agreement.” E.g., Neurodiagnostic Tex, LLC v. Pierce, 506 S.W.3d 153, 164-65 (Tex. App.—Tyler 2016, no pet.). See also Texas Non-Compete Case Teaches Importance of Providing Specialized Training.  

That means a Texas non-compete doesn’t necessarily need to provide for specialized training, but it’s a good idea, if the company is actually going to provide the employee specialized training. My specialized training clause looks like this:

The important thing is to include a description that is specific enough to persuade a judge that this is not mere boilerplate. A generic promise of providing specialized training may not cut it, especially if the company later struggles to identify what the training was and why it was “specialized.”

4. Does the non-compete need a complicated definition of competing?

You can probably already guess where I come out on this one. Most non-competes have a pretty wordy definition of competing. Here’s a typical example:

This way of describing the prohibited competition isn’t really wrong, but it strikes me as unnecessarily complicated. You want to be able to put the clause in front of a judge or jury and make it as simple as possible.

I suspect the more complicated clauses came about as a result of clever employees coming up with ways to circumvent the non-compete.

You can imagine. “I know,” the employee says, “for the first year I’ll be an unpaid consultant to an LLC that my brother-in-law forms, so I won’t really be competing.”

I’m sure there have been endless variations on this sort of thing. And it almost never works. I think most judges and juries are smart enough to figure out that this kind of thing still violates an agreement not to “compete” with the employer.

On the other hand, you don’t want your non-compete to be vulnerable to shenanigans like this. Courts will decline to enforce the claimed purpose of the non-compete when the unambiguous language establishes that the non-compete does not apply. See, e.g., Total Safety U.S., Inc. v. Code Red Safety & Rental, LLC, No. 4:19-CV-03836, 2020 WL 57775826, at *4 (S.D. Tex. Sept. 4, 2020) (rejecting employer’s argument that employment did not terminate when employee was promoted and went to work for an affiliate).

So, even though I favor simplicity and plain language, I do include the common non-compete modifier “directly or indirectly” in my form:

You agree not to compete with us or to help anyone compete with us, directly or indirectly, . . .

I also include the “or to help anyone complete with us.” I think this is a good plain-language way to cover most scenarios where the employee tries to get around the non-compete by working through a middleman.

So now you’ve got a non-compete that meets the “ancillary to an otherwise enforceable agreement” requirement, because it expressly promises to give the employee confidential information and/or specialized training. And you’ve got a common-sense definition of competing.

All you need now are reasonable limitations on time period, geographic area, and scope of activity. How should you draft those limitations?

Stay tuned for Part 2.

______________________________________

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

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

Geographic Area of a Texas Non-Compete – Part 2

Geographic Area of a Texas Non-Compete – Part 2

If Part 1 was a flashback to the vinyl era, then this Part 2 moves us into the cassette era. That’s more my time. I never actually had a Peter Frampton record, but I can still remember recording The Name of This Band is Talking Heads on to a blank cassette tape.

The theme of Part 1 was the Sales Territory principle, which says that a reasonable geographic area for a Texas non-compete should usually coincide with an employee’s actual sales territory. This principle goes all the way back to the first vinyl era, the Jazz Age, when Texas courts reasoned that an employee is going to develop goodwill only in the area where he has personal contact with customers.

But of course, not every case involves the typical sales employee who is responsible for a certain territory. What about cases where physical territory is not important, or where the employee is a high-level executive?

In such cases, the Sales Territory principle may be less useful, and Texas courts may be more likely to follow what I call the Holistic principle. The Holistic principle considers the reasonableness of the geographic limitation not in isolation, but in combination with other factors, such as the employee’s rank in the company, the employee’s knowledge of high-level confidential information, the nature of the business, and perhaps most important, the scope of activity restrained by the non-compete.

This leads us to General Rule No. 5.

General Rule 5: No geographic limitation or broad geographic limitation + non-compete limited to existing customers = probably reasonable.

The Sales Territory principle was rooted in the idea that customer goodwill is usually tied to a certain geographic territory. This idea goes back at least as far as the City Ice Delivery case in the 1920s. But Texas courts also recognized decades ago that even a non-compete with no geographic limitation at all can be reasonably limited to protecting customer goodwill, if the scope of activity it restrains is narrow.

Consider Stocks v. Banner American Corp., 599 S.W.2d 665 (Tex. Civ. App.—Texarkana 1980, no writ). Stocks sold his stock in Banner and agreed not to compete with Banner for three years. Banner’s business included manufacturing and selling blank cassette tapes, selling blank labels for cassette tapes, and custom duplication of cassette tapes. Banner’s customers included Tandy Corporation and Apple Computers. Id. at 666.

Stocks apparently could not leave the cassette game behind, because he somehow became an owner of Xalon Corporation, which sounds like an evil company from Aliens or Terminator. Despite the lack of any geographic limitation in the non-compete, the trial court enjoined Stocks and Xalon Corporation from doing business with Tandy, Apple, or a list of other Banner customers. Id. at 666-67.

The Court of Appeals found that the lack of a geographic area was not fatal to the non-compete. See id. at 667 (“Failure to include a territorial limitation will not void a covenant to compete”). The court cited Justin Belt Company, Inc. v. Yost, 502 S.W.2d 681 (Tex. 1973), where the court held that a non-compete that was “unlimited both as to time and to space” could be enforced to a reasonable extent. Id. The court also reasoned that non-competes may be construed more broadly in the sale of a business than in an employment relationship. Id. (citing Seline v. Baker, 536 S.W.2d 631 (Tex. Civ. App.—Houston [1st Dist.] 1976, no writ)).

Thus, the non-compete could be enforced to some extent, despite the lack of a geographic limitation. But to what extent? The Stocks court cited two cases approving injunctions limited to prohibiting a former employee from contacting certain listed customers. Id. at 667-68 (citing Toch v. Eric Schuster Corp., 490 S.W.2d 618 (Tex. Civ. App.—Dallas 1972, writ ref’d n.r.e.), and Arrow Chem. Corp. v. Anderson, 386 S.W.2d 309 (Tex. Civ. App.—Dallas 1965, writ ref’d n.r.e.)). The takeaway was that “[t]he use of a customer list as an alternative to setting a specific geographical limit is a reasonable means of enforcing a covenant not to compete.” Id. at 668.

Apple Computers was one of the key customers in the Stocks case decided in 1980

From the Stocks rule we can deduce this common-law principle of Texas non-compete law: a non-compete that is limited to prohibiting a former employee or owner from doing business with the company’s existing customers may be reasonable and enforceable even if it lacks a geographic limitation. See also Investors Diversified Servs., Inc. v. McElroy, 645 S.W.2d 338, 339 (Tex. App.—Corpus Christi 1982, no writ) (non-compete limited to clients securities salesmen contacted or learned about while working for company was enforceable despite lack of defined territory).

The logic of the rule is that the point of requiring a geographic limitation was to protect customer goodwill. If the non-compete is otherwise limited to protecting customer goodwill—because it is limited to the company’s existing customers—then a geographic limitation may not be necessary. This is the most basic formulation of the Holistic principle.

But this was a common-law rule. Did the Stocks rule survive the enactment of the Texas non-compete in 1989? Let’s just say the Stocks rule fared better than cassette tapes at the end of the 80s.

Even though the statute expressly requires a geographical limitation, Texas courts continued to hold that a geographic limitation may be unnecessary if the scope of activity restrained is sufficiently narrow.

In Totino v. Alexander & Associates, Inc., No. 01-97-01204-CV, 1998 WL 552818 (Tex. App.—Dallas Aug. 20, 1998), former employees of an insurance brokerage argued that the their non-competes violated the statute because they contained no geographic limitation, but the court rejected this argument. Id. at *3. The statute’s reasonable geographic restriction parallels a similar common-law requirement, the court reasoned, and Texas courts had held that a geographic limitation was not necessary where the non-compete was limited to clients the former employee had contact with. Id. at *3-4 (citing McElroy and Stocks). The non-compete “implicitly” contained a reasonable geographic restriction because it was limited to clients of the brokerage. Id. at *4.

The First Court of Appeals followed the same approach in Gallagher Healthcare Insurance Services v. Vogelsang, 312 S.W.3d 640 (Tex. App.—Houston [1st Dist.] 2009, pet. denied). The non-compete in Gallagher had no geographic limitation, but it was limited to clients the employee had worked with in her last two years at the company. Id. at 654. “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,” the court said, citing Stocks, Totino, and McElroy. Id. at 654-55. The court held the limitation to clients the employee worked with while employed by the company was a “reasonable alternative to geographical area.” Id. at 655.

As these cases illustrate, the scope of activity restrained is usually a more important factor than geographic area. Even a non-compete that has a reasonable geographic area will be unenforceable if the scope of activity restrained is too broad. See Burning Down the Haas: The Industry-Wide Exclusion Rule in Texas Non-Compete Litigation.

The employee’s position in the company is also an important factor, which leads to the next general rule.

General Rule 6: No geographic limitation or broad geographic limitation + non-compete not limited to specified customers + high-level executive = It depends.

We have seen that a broad geographic area—or even the lack of any geographic area—may be found reasonable if the non-compete is limited to existing clients or customers. But what if the non-compete is not limited to existing clients or customers?

This is where it gets hard. In a case like this, other factors, such as the employee’s rank in the company and knowledge of the company’s confidential information, become more important.

The Stocks rule lasted longer than these bad boys

Judge Ellison considered the issue in detail in M-I LLC v. Stelly, 733 F.Supp.2d 759 (S.D. Tex. 2010). In that case, Knobloch resigned from his position as Manager of Sales for the Americas at M-I, an oilfield services company. He started his own oilfield services company and allegedly started “raiding” employees from M-I. Id. at 769-70.

Knobloch’s non-compete restricted doing business with existing M-I customers, but it did not end there. Like many non-competes, it also prohibited Knobloch from engaging in any business “involving oilfield displacement tools or services or any other businesses then conducted by Employer.” Id. at 794. These restrictions applied “in any geographic area” where the company did business, which effectively meant North America, South America, and the Caribbean. Id. at 797.

Knobloch argued that his non-compete was unenforceable because the geographic area was too broad, but Judge Ellison disagreed, citing his own formulation of the Holistic principle. “[N]on-compete covenants with restrictions covering a wide geographic area may be reasonable if they are limited in scope to a firm’s current or prospective clients such that they do not pose a greater restraint than necessary to protect the firm’s goodwill,” he said, citing his own opinion in TransPerfect Translations (I love that flex). Id. at 797-98.

He also cited a version of the Sales Territory principle: “Covenants with wide geographic areas have been upheld frequently in Texas courts, especially when the area covered constitutes the employee’s actual sales or work territory.” Id. at 798.

Applying these rules, Judge Ellison acknowledged that “a geographic area covering the Western hemisphere is broad, reaching to the outer limits of a restriction.” But he ruled that this broad geographic area was reasonable, even where the non-compete was not limited to existing customers, where:

  • Knobloch had “extensive job responsibilities” and held a position in “upper management” (Manager of Sales for the Americas). He was “much more than a manager and salesman for his former employer.” He oversaw the company’s “relationships with major international clients.”
  • His actual territory did span the Americas.
  • Knobloch knew the company’s technical confidential information: “An engineer by training, Knobloch participated in the design of [the company’s] tools and in facilitating wellbore completions. He delivered technical presentations internationally, formulated company growth strategies, and discussed product development with engineers.”

Id. at 798-99.

In short, in M-I v. Stelly the geographic area covering the entire Western hemisphere was reasonable where the employee was a high-level executive, he was actually responsible for that territory, and he had knowledge of the company’s confidential technical information.

M-I v. Stelly took a “holistic” approach

Texas cases since M-I v. Stelly have tended to find broad geographic areas reasonable when the former employee was a high-level executive.

Consider Daily Instruments Corp. v. Heidt, 998 F.Supp.2d 553 (S.D. Tex. 2014). In that case, the non-compete broadly applied to the United States and any country in which Daily Instruments did business. Id. at 567. Daily Instruments specialized in the narrow field of reactor thermometry, which involved electrical temperature measurement devices used in reactors for the refining, chemical, and petrochemical industries. Id. at 557.

The court found the non-compete reasonable for three reasons. First, the employee was a high-level sales manager with responsibility for a very large territory and with access to the company’s confidential information regarding worldwide clients and sales. Id. at 567-68. Second, the field of reactor thermometry was very narrow, with a narrow customer base, few competitors, and a global scale. Id. at 568. Third, the non-compete had a reasonable limitation on scope because it did not bar the employee from working in the industry, but only from performing the kind of work he had performed in his last two years of employment in the narrow field of reactor thermometry products, and from disclosing confidential information. Id.

Similarly, in Ameripath, Inc. v. Hebert, 447 S.W.3d 319, 335 (Tex. App.—Dallas 2014, pet. denied), the court found a broad geographic area reasonable considering the employee was a member of employer’s “highest level management team.” The employee cited the Sales Territory principle and argued that he only worked in two counties, while the geographic scope of the non-compete was much broader. Id.

But the court said “the breadth of enforceable geographical restrictions in covenants not to compete must depend on the nature and extent of the employer’s business and the degree of the employee’s involvement in that business.” Id. (citing Butler v. Arrow Mirror & Glass, Inc., 51 S.W.3d 787, 793 (Tex. App.—Houston [1st Dist.] 2001, no pet.). The restriction on working anywhere for a company that operated in the Dallas-Fort Worth area was reasonable, the court reasoned, because the employee’s “management knowledge of and experience with [the company’s] Dallas-area operations would be valuable to his new employer.”

And in McKissock, LLC v. Martin, 267 F.Supp.3d 841, 856-57 (W.D. Tex. 2016), the court found a nationwide geographic area reasonable, where the company had a national customer base, the employee taught online courses available to the national customer base, and the employee held an upper-level position as Senior Appraisal Instructor.

Hmm. “Senior Appraisal Instructor.” I’m wondering how “upper-level” that really was. In theory, I don’t have a problem with the Holistic principle applied in M-I v. Stelly and subsequent cases. Courts should remember that the primary rationale for requiring a geographic limitation is to protect a company’s goodwill.

But I fear that in practice, dispensing with the geographic limitation requirement or allowing an extremely broad geographic area can have a real chilling effect on the ability of businesses to hire the best executive talent. I’ve seen this in my practice.

Maybe it’s time to hit rewind.

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

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

Geographic Area of a Texas Non-Compete – Part 1

Geographic Area of a Texas Non-Compete – Part 1

The reasonable geographic area requirement of Texas non-compete law is delightfully dated. It’s an analog throwback in a digital era. When Texas courts say a non-compete must be limited to a reasonable geographic area, you can just feel the needle dropping into the well-worn grooves of your uncle’s vinyl copy of Frampton Comes Alive!

But some of you will object that requiring a geographic limitation in a non-compete is an obsolete relic of a bygone era, like Microsoft stores. We’re in the WFH era now. The physical location of an employee doesn’t matter. You might argue a sales person with a cell phone and a laptop can do just as much damage to your business from a beach chair in Fiji as a cubicle in Pearland.

Maybe so. But if the non-compete says “within Pearland,” you’re kind of stuck with that. Plus, the Texas non-compete statute still requires a non-compete to have a reasonable limitation as to “geographical area.” Tex. Bus. & Com. Code § 15.50(a).

The traditional connection between physical proximity and customer goodwill

This is perhaps the most old-fashioned part of Texas non-compete law. It hearkens back to a time when physical proximity was the key to a salesman maintaining goodwill with the customer.

Consider Randolph v. Graham, 254 S.W. 402, 403-4 (Tex. App.—San Antonio 1923, writ ref’d), where the court held that a medical practice non-compete was reasonable and enforceable, despite having no time limitation, because it was limited to practicing medicine within a 20-mile radius of Schertz, Texas.

The court didn’t explain why the geographic area was reasonable, but it’s easy to understand. People like to go to a doctor with an office near them. So, if a doctor sells his practice in Schertz and moves to Austin, it is unlikely his patients will follow him. (The drive from Schertz to Austin is 65 miles up I-35, which usually takes 5-7 hours.) A 20-mile radius sounds about right to prevent the doctor from taking advantage of the goodwill he developed with his patients.

Two years later, the geographic limitation requirement took shape in City Ice Delivery Co. v. Evans, 275 S.W. 87 (Tex. Civ. App.—Dallas 1925, no writ). The court said the test for enforceability of a non-compete in an employment contract was whether it imposed “any greater restraint than is reasonably necessary to secure protection of the business of the employer or the good will thereof.” Id. at 90.

Applying this principle to the geographic area of the non-compete, the court held that the employer was entitled to an injunction against the employee competing in the ice delivery business in the territory where he had delivered ice to the company’s customers, but not against competition outside of the territory, where the company had no goodwill based on the employee’s “personal contact” with customers. Id.

Again, we can see why it made sense to limit the non-compete to the employee’s delivery area. In a business that involves physical delivery of the product to the customer, it was unlikely that a salesman was going to develop goodwill with customers outside his delivery area. Especially in 1925, when the ice would melt if you had to go too far.

So there you have it. Two keys to the geographic area requirement: (1) it should be limited to the territory where the employee interacted with customers, because (2) that is the area where the employee developed goodwill with the customers on behalf of the company.

64 years later, the Texas legislature enacted the 1989 non-compete statute. It provides that a non-compete must contain limitations as to time, geographical area, and scope of activity to be restrained that are “reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee.” Tex. Bus. & Com. Code § 15.50(a).

How have Texas courts interpreted the statute’s reasonable geographic area requirement? In principle, not much has changed since City Ice Delivery.

The Sales Territory principle

In most cases, where the employee worked in some kind of customer-facing sales role within a defined territory, the reasonableness of the geographic area will turn on whether it matches the employee’s sales territory. Let’s call this the Sales Territory principle.

When the case involves a sales person or other low to mid-level employee, the Sales Territory principle will usually explain why the court found the geographic area reasonable or unreasonable. In other words, the Sales Territory principle usually applies when the case does not involve a high-level executive. That leads to our first general rule.

General Rule 1: Non-executive + no geographic limitation = probably unreasonable

The easiest cases are those involving a non-executive who has a non-compete with no geographic limitation.

One of the first cases to apply the statute’s geographic area requirement was Zep Manufacturing Co. v. Harthcock, 824 S.W.2d 654 (Tex. App.—Dallas 1992, no writ). That case involved a non-compete between Zep, an industrial chemical manufacturer, and Harthcock, an industrial chemist. Id. at 656-57. Harthcock’s non-compete barred him from performing services similar to those he performed for Zep for two years following termination, with no geographic limitation. Id. at 660.

The court cited the general principle that “what constitutes a reasonable area generally is considered to be the territory in which the employee worked while in the employment of his employer.” Id. (citing two pre-statute cases, Justin Belt Co. v. Yost, 502 S.W.2d 681, 685 (Tex. 1973), and Diversified Human Resources Group v. Levinson-Polakoff, 752 S.W.2d 8, 12 (Tex. App.—Dallas 1988, no writ)).

The court then said the non-compete failed to comply with the statute because it contained no limitation as to geographic area. Id. at 661. Thus, the non-compete would prohibit Harthcock from working as an industrial chemist anywhere, regardless of whether it was in an area not serviced by Zep or Harthcock.

“Noncompete covenants with broad geographical scopes have been held unenforceable,” the court said, “particularly when no evidence establishes that the employee actually worked in all areas covered by the covenant.” Because the non-compete contained no geographic restriction, the court held it was unenforceable. Id.

But today, most Texas lawyers are smart enough to include some geographic limitation in the non-compete. What then?

General Rule 2: Non-executive + ill-defined geographic limitation = probably unreasonable

Texas courts have reached similar conclusions when the non-compete has some geographic limitation, but is so broad or vague that it has no connection to protecting the goodwill developed by the employee.

For example, in TENS Rx, Inc. v. Hanis, No. 09-18-00217-CV, 2019 WL 6598174, at *1 (Tex. App.—Beaumont Dec. 5, 2019, no pet.) (mem. op.), the non-compete applied “in any state or geographical territory in which Employer is conducting, has conducted or anticipates conducting its business.”

The employee filed a motion for summary judgment that the non-compete was unenforceable because the geographic limitation and scope of activity restrained were unreasonable. Id. at *2. The employer argued that the employee was bound by the contractual stipulation that the geographic restriction was reasonable, stating it was “disingenuous” for the employee to now assert the contrary. Id. at *3.

This brings up one of my pet peeves: lawyers for the first employer love to argue that the employee is being dishonest or “disingenuous” when the the non-compete recites that its limitations are reasonable and the employee later argues they’re unreasonable. I don’t find this persuasive, and I’m guessing most judges don’t either. Almost every non-compete contains self-serving recitals like this. Even when I’m representing the employer trying to enforce the non-compete, I would rather just demonstrate that the limitation is reasonable than play this game.

In any case, the trial court in TENS Rx didn’t buy the “disingenuous” argument. It granted summary judgment that the non-compete was unreasonable in geographic scope and scope of activity restrained. Id.

Because the non-compete related to provision of personal services, the employer had the burden to prove the non-compete was reasonable. Id. at *4. On appeal, the employer cited no authority that the restrictions were reasonable, instead merely arguing that the employee was bound by the contract’s stipulation that the restrictions were reasonable. Id. at *4. The court appeared to reject this argument, instead looking to Texas case law on reasonableness of a geographic limitation. Id.

The question is “whether the covenant contains limitations that are reasonable as to geographical area and do not ‘impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee.’” Id. (citing Marsh USA Inc. v. Vook, 354 S.W.3d 764, 777 (Tex. 2011)).

“The territory in which the employee worked for an employer is generally considered to be the benchmark of a reasonable geographic restriction,” the court said. Id. “Noncompete covenants with broad geographical scopes have been held unenforceable, particularly when no evidence establishes that the employee actually worked in all areas covered by the covenant.” Id.

“Here, there is no definite territory stated and no evidence that Hanis worked in all areas covered by the covenant,” the court said. “It is also unreasonable to impose a condition upon Hanis that would require her to know where TENS ‘anticipates doing its business.’” Id.

close-up-photo-of-assorted-color-of-push-pins-on-map-1078850
Sales territory is usually the benchmark for a reasonable geographic area

TENS Rx shows the risk of making the geographic limitation too abstract. Sure, there is some logic to defining the area as “the employee’s sales territory.” What better way to comply with the Sales Territory principle? But the risk of defining the geographic area this way is that the court may say it is too indefinite. How are the employee—and the court—to know what the sales territory is if it’s not spelled out in the contract?

On the other hand, the company may not know in advance what the employee’s sales territory will be. What if the employee works for the company for over a decade and the territory changes? I don’t have any foolproof solution to this problem, other than to say that usually the better practice is to include a specific geographic area that predicts, as well as the company can, what the employee’s likely sales territory will be.

Let’s say the employer tries to do that and limits the non-compete to a specific, concrete geographic area, such as “within Harris County, Texas.” Is that reasonable? It will probably depend on the employee’s actual sales territory, which leads us to the next general rule.

General Rule 3: Non-executive + well-defined geographic area broader than sales territory = probably unreasonable

When the employee is not a high-level executive and the non-compete has a specific geographic area, the question will be whether the geographic area is broader than the employee’s actual sales territory.

This creates an obvious problem. Dozens of Texas cases say that the reasonableness of a non-compete is a question of law. But how can a judge decide the reasonableness of the non-compete’s geographic area without considering extrinsic evidence about the facts?

Suppose the non-compete’s stated geographic area is “within Harris County, Texas and surrounding counties.” On a motion for summary judgment, the Employee signs a sworn affidavit stating “my sales territory was limited to Harris County,” while the Employer’s CEO signs a sworn affidavit stating “Employee’s sales territory included Harris County and all the surrounding counties.” In other words, conflicting evidence. How can the trial court decide that issue as a question of law?

It can’t. And this illustrates why Texas courts are simply wrong when they declare that the reasonableness of a geographic limitation is always a question of law. On the other hand, if the facts regarding the employee’s sales territory are undisputed, then the reasonableness of the geographic area could present a question of law for the court.

Consider Fomine v. Barrett, No. 01-17-00401-CV, 2018 WL 6376500, at *1 (Tex. App.—Houston [1st Dist.] Dec. 6, 2018, no pet.), which prohibited a chiropractic case manager from competing within a 500-mile radius of the clinic’s location. The former case manager, Barrett, moved for summary judgment that the geographic limitation was unreasonable, extending beyond her work responsibilities for the clinic. Id. at *2.

The Court of Appeals affirmed summary judgment for Barrett. The court began by citing the Sales Territory principle, i.e. “[t]he territory in which an employee worked for an employer is generally considered to be the benchmark of a reasonable geographic restriction.” Id. at *3.

The clinic argued that a 500-mile radius was reasonable because Barrett marketed to patients throughout the State of Texas, but the court rejected this argument. Even assuming Barrett’s sales territory included all of Texas, a 500-mile radius would include all of Louisiana and significant portions of Alabama, Arkansas, Mississippi, Oklahoma, and Mexico. Id. at *3. The geographic scope was therefore “significantly broader” than the geographic scope of Barrett’s employment with the clinic, and the non-compete was therefore unenforceable as written. Id. at *4.

Fomine shows the importance of the employer offering evidence that an employee responsible for generating sales actually worked in the entire geographic area stated in the non-compete. Otherwise the area may be found broader than necessary to protect the employer’s goodwill.

The Sales Territory principle can also apply when the defendant is not a sales employee. Ortega v. Abel, 562 S.W.3d 604 (Tex. App.—Houston [1st Dist.] 2018, pet. denied), was a non-compete case involving the sale of a Hispanic-themed grocery store chain. The geographic area was a 10-mile radius from each of the five stores sold, which equated to most of the Greater Houston area. Id. at 611. The defendants’ expert testified that a three-mile radius would be more than sufficient to protect the goodwill of each store, reasoning that people in a city like Houston rarely travel more than 10 to 12 minutes to go to the grocery store. Id. The plaintiff, Ortega, did not present any evidence to contradict this testimony. Id. at 612.

The Court of Appeals held that the evidence was sufficient to support the trial court’s determination that the 10-mile radius in the non-compete was greater  than necessary to protect Ortega’s goodwill. Id. The court reasoned that “[t]he goal of a covenant not to compete is to establish the restraints on trade reasonably necessary to protect the goodwill or other business interest of the promise, not to prevent any competition.” Id. The expert’s testimony supported the trial court’s conclusion that a 3-mile radius was sufficient. Id.

General Rule 4: Non-executive + geographic area basically matching sales territory = probably reasonable

The next application of the Sales Territory principle is where the employee is a sales person or other lower to mid-level employee, and it is undisputed that the geographic area matches the sales territory the employee actually worked (or is at least pretty close).

That presents a fairly easy case for the court to hold that the geographic area is reasonable.

For example, in Gehrke v. Merritt Hawkins & Associates, LLC, No. 05-18-001160-CV, 2020 WL 400175, at *4 (Tex. App.—Dallas Jan. 23, 2020, no pet. h.), the non-compete between a national physician recruiting firm and a salesman prohibited competition in states in which the salesman worked during his last year with the firm. The court held that the multi-state geographic restriction was enforceable because the salesman actually worked within those states. Id.

But of course not every case involves an ordinary sales-level employee. What if the employee was a high-ranking executive who knew everything about the company and was responsible for all of the company’s customers?

I feel like I should save that for Part 2.

Do you feel like I do?

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IMG_4571Zach 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.

Recent Case Illustrates Catch-22 for Texas Non-Compete Injunctions

Recent Case Illustrates Catch-22 for Texas Non-Compete Injunctions

They say the early bird gets the worm, but they also say all good things come to those who wait. In Texas non-compete litigation, both things can be true.

Let’s illustrate with a hypothetical. Dawn Davis leaves her sale job at Paula Payne Windows and goes to work for a fierce competitor, Real Cheap Windows. Company president Paula Payne calls her outside counsel and says, “Johnny, you’ve got to do something before Dawn takes her customers with her.”

“Have any of them left yet,” he asks. “No,” Paula says, “but it’s only a matter of time.” (#Hamilton)

“Here’s the problem,” Johnny says. “To get an injunction, I’ve got to show imminent harm, and the mere fact that she joined a competitor may not be enough.”

Paula Payne Windows reluctantly decides to wait. Then, over the next four weeks, half of Dawn’s customers stop ordering from Paula Payne and start buying their windows from Real Cheap.

Desperate to stop the bleeding, Paula Payne assigns a new sales guy, Eric Boonster, to the rest of Dawn’s accounts. But Eric doesn’t have Dawn’s experience, or her personal relationships with the customers. Two more customers jump to Real Cheap.

That’s the last straw. Paula Payne Windows sues Dawn and Real Cheap in Texas state court. Paula Payne asks the judge for a temporary injunction barring Dawn from doing business with any of the customers she serviced while working for Paula Payne.

At the hearing, Paula Payne Windows argues that its new sales guy can service Dawn’s customers, and that the customers will stick with Paula Payne Windows if the court orders Dawn to stop doing business with them. But on cross examination, Paula admits the customers are free to go to any company they want, and that she could quantify the amount of lost profits from any sales the company loses to Real Cheap.

Dawn doesn’t buy it. She gets on the stand and says, “I’ve known most of these customers for years, and there’s no way they will stay with Paula Payne if the court tells them they’re not allowed to keep buying from me.”

So, under Texas law, what is the correct ruling by the trial court judge?

(A) Grant a temporary injunction prohibiting Dawn from doing business with any of her former customers from Paula Payne Windows from that point forward. The loss of sales and customer goodwill establishes irreparable injury.

(B) Grant a temporary injunction prohibiting Dawn from soliciting or doing business with any of her former customers who have not yet left Paula Payne Windows, because there is insufficient evidence the customers who have already left would go back to Paula Payne Windows.

(C) Deny a temporary injunction. There is no evidence the customers at issue will buy from Paula Payne if they can’t buy from Dawn, and any sales Paula Payne loses can be adequately compensated with damages.

Personally, I tend to favor answer C, for reasons I explained in The Problem With Non-Competes. But to be fair, you can make a case for each one of these choices. You can find Texas cases to support any one of them.

In one recent case, the court chose answer B, the intermediate option. There is some logic to that choice, as we will see, but it results in a dilemma for the employer who is trying to enforce the non-compete and hold on to customers.

The Gallagher Case

In Gallagher Benefit Services v. Richardson, No. 6:19-cv-00427, 2020 WL 1435111 (E.D. Tex. March 24, 2020), Richardson admitted she was servicing over 60 former Gallagher insurance clients, despite her two-year non-compete. Gallagher sued Richardson for breach of non-compete and sought a preliminary injunction in federal court.

A preliminary injunction requires proof of a substantial threat of irreparable harm. The judge’s ruling on this element was mixed.

As to clients who were still doing business with Gallagher, the court found that Richardson’s admitted possession of a Gallagher producer report and servicing of former Gallagher clients established a threat of irreparable harm. Id. at *6.

But why would this harm be irreparable if Gallagher could obtain lost profits damages for the loss of client business?

“As to the violation of the noncompete clause,” the court said, “irreparable harm may be shown where future damages would require quantification estimates that can be avoided by an injunction that prevents the damages in the first place.” That harm could be avoided, and the status quo preserved, by enjoining Richardson from recruiting or working for any current Gallagher clients. Id.

If those clients leave Gallagher as a result of Richardon’s competition, the court acknowledged, Gallagher could attempt to quantify its damages. “But that quantification will involve estimates and thus potential undercompensation,” the court said. That irreparable harm can be avoided by an injunction against competition for current Gallagher clients, the court reasoned, noting that courts “routinely” enjoin prohibited competition in these circumstances. Id. (citing federal district court cases).

On the other hand, the court rejected Gallagher’s irreparable harm argument as to clients Richardson was already servicing. The court had specifically asked what evidence supported Gallagher’s argument that Richardson’s current clients would have stayed with Gallagher, id. at *2, and Gallagher argued that the court could “infer” that some of the clients would return to Gallagher if the court enjoined Richardson. Id. at *6. But the court said Gallagher did not prove sufficient facts to support that inference, including its capacity to service those clients.

Therefore, as to clients who had already left Gallagher for Richardson, the court found there was not enough risk to warrant disrupting the status quo with an injunction. Id. at *7.

“Without evidence of how many additional competitors Gallagher faces in the marketplace, or of Gallagher’s ability and realistic prospects of regaining any of the clients now with Richardson,” the court said, “Gallagher has not met its burden of showing more than this minimal extent [of] irreparable injury.” Id. at *8.

The court noted that “other courts have also been hesitant to eliminate a defendant’s book of business where the plaintiff has not offered sufficient evidence that the clients in question would return to the plaintiff.” Id. (citing First W. Capital Mgmt. Co. v. Malmed, No. 16-cv-1961-WJM-MJW, 2016 WL 8358549, at *11-12 (D. Colo. Sep. 30, 2016)).

Based on this reasoning, the court entered a preliminary injunction that prohibited Richardson from doing business with any Gallagher clients she serviced during her last two years at Gallagher, except for accounts she was already servicing as of the date of the injunction. Id. at *7.

The Gallagher Dilemma

Gallagher v. Richardson illustrates a Catch-22 facing an employer who wants to get an injunction to stop a former employee from taking customers with her. If the employer files suit and asks for an injunction before customers have left, it may be difficult to prove imminent harm, because the employee hasn’t violated the non-compete yet. But if the employer waits until after customers have left, the judge may take the Gallagher v. Richardson approach and say it’s too late to get an injunction to stop the employee from doing business with those customers.

So what is the employer with the non-compete to do?

Ideally, the employer would offer testimony that it has the ability to service the customers even without the ex-employee and that the customers are likely to continue doing business with it.

If the employer can get some of the customers to vouch for this, even better, but that’s usually hard to pull off. The last thing you want to do when you’re trying to hold on to customers is drag them into a lawsuit, especially when you’re asking them to testify against the sales person they like. And if the customer already wants to stay with you, why would you need an injunction?

So the employer may have trouble persuading the trial judge the customers will come back, and it may get stuck with the intermediate result of Gallagher v. Richardson. For that reason, some might say the lesson of the Gallagher case is that the employer should immediately file suit when the employee leaves to join a competitor.

That’s a plausible position, but it strikes me as too simplistic. What if you go to the temporary injunction hearing before any customer has left, and the employee testifies that she only plans to go after new customers? How are you going to show imminent harm? This approach strikes me as too hot.

Perhaps the “just right” approach is to monitor the situation closely and file suit as soon as two or three customers jump ship. Then you can point to those defections as evidence of imminent harm, but you can try to get an injunction to stop the employee from taking any other customers.

This still leaves the question of why damages would be inadequate.  But the employer at least has cases it can cite on that issue—as the Gallagher opinion illustrates.

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IMG_4571Zach 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.

 

Can a Non-Compete Grant an Injunction by Stipulation?

Can a Non-Compete Grant an Injunction by Stipulation?

Listen. Do you want to know a secret? It doesn’t really matter whether a contractual stipulation to an injunction is binding on a court.

Still, most non-competes contain some kind of stipulation that a breach will cause the company irreparable injury, and the company is therefore entitled to an injunction in the event of a breach. Let’s call this an “ipso facto” clause.

There are essentially four ways courts can approach an ipso facto clause:

  1. Find it enforceable and dispositive.
  2. Consider it as a factor favoring an injunction.
  3. Cite it as a factor, but without really giving it any weight.
  4. Disregard it entirely.

In my personal opinion, no. 4 is the correct approach. I don’t think a judge should give this kind of stipulation any weight. We wouldn’t let private parties stipulate to their own rules of evidence or procedure. And it seems especially inappropriate for a temporary injunction, which is both an “extraordinary” remedy and, traditionally, an “equitable” remedy left to the discretion of the judge.

You might cite “freedom of contract.” Ok, but how much weight would you give a clause that says “in the event of any litigation between Company and Employee, the court shall declare Company the winner”?

No, I don’t think this is the kind of decision we let private parties dictate in advance, and that may explain why you won’t find many Texas cases saying an ipso facto clause is dispositive and binding on the court.

In Wright v. Sport Supply Group, Inc., 137 S.W.3d 289, 293-94 (Tex. App.—Beaumont 2004, no pet.), the court said it was unaware of any Texas case holding that an ipso facto clause alone establishes, for injunction purposes, that remedies at law will be inadequate. And in Shoreline Gas, Inc. v. McGaughey, No. 13-07-364-CV, 2008 WL 1747624, *11 (Tex. App.—Corpus Christi 2008, no pet.) (mem. op.), the court, citing Wright, said the employer cited no Texas case holding that an ipso facto clause proves there is irreparable injury or no adequate remedy at law.

Addressing an analogous issue, the court in Forum US, Inc. v. Musselwhite, No. 14-17-00708-CV, 2020 WL 4331442 (Tex. App.–Houston [14th Dist.] July 28, 2020, no pet. h.) (mem. op.), rejected the employer’s argument that the non-compete was reasonable because the agreement recited it was reasonable. “If the rule was otherwise,” the court explained, “every employer could require employees to sign an acknowledgement or reasonableness as a condition of employment and courts would be powerless to hold unreasonable covenants not to compete unenforceable as a violation of Texas public policy.” Id. at *10.

But Texas courts have sometimes cited ipso facto clauses as a factor to consider. In Wright, the court held that an ipso facto clause provided some “substantive and probative evidence” to support the trial court’s temporary injunction, citing the strong public policy of Texas favoring freedom of contract. Wright, 137 S.W.3d at 294.

This kind of “punting” seems to be the most common approach. See South Plains Sno, Inc. v. Eskimo Hut Worldwide, Ltd., No. 07-19-00003-CV, 2019 WL 1591994, at *6 (Tex. App.—Amarillo April 12, 2019, no pet.) (mem. op.) (citing ipso facto clause, in addition to evidence of irreparable injury, in support of affirming trial court’s temporary injunction); Poole v. U.S. Money Reserve, Inc., No. 09-08-137CV, 2008 WL 4735602, at *8 (Tex. App.—Beaumont Oct. 30, 2008, no pet.) (mem. op.) (citing ipso facto clause as “but one consideration in our analysis”).

Citing the ipso facto clause as a non-dispositive factor is kind of an easy way out, so I get why courts would do it. But I wonder. In these cases where courts cited an ipso facto clause as a factor, did the clause actually make a difference? In other words, would the case have come out the same way if the agreement had no such clause?

I suspect the answer is yes, but of course there is no way to be sure.

I do know of at least one Texas case that seemed to find an ipso facto clause conclusive. In Henderson v. KRTS, Inc., 822 S.W.2d 769 (Tex. App.—Houston [1st Dist.] 1992, no writ), the buyer of a radio station obtained a temporary injunction prohibiting the seller from interfering with the buyer’s efforts to move the station. Id. at 771-73. On appeal, the seller argued the temporary injunction was improper because damages would be an adequate remedy. The Court of Appeals disagreed, citing the ipso facto clause. The court held that the seller, “by agreement, stipulated that [the buyer] could seek injunctive relief without the necessity of proof of actual damages.” Id. at 776. But the opinion simply decreed this without any analysis.

In a more recent case, the First Court of Appeals reached the opposite conclusion, without citing Henderson. In Malone v. PLH Group, Inc., No. 01-19-00016-CV, 2020 WL 1680058 (Tex. App.—Houston [1st Dist.] Apr. 7, 2020, no pet. h.) (mem. op.), the court said an ipso clause had no effect.

The employment agreement in Malone contained restrictive covenants prohibiting the employee from competing against the company, soliciting the company’s employees, and using or disclosing the company’s confidential information. Id. at *1. The agreement also contained an ipso facto clause, stating any breach of the restrictive covenants would cause “irreparable damage” to the company, and the company “will be entitled as a matter of right to equitable relief, including temporary or permanent injunction, to restrain such breach.” Id.

After a bench trial, the trial court found that the employee breached the confidentiality clause by forwarding a bid log report to his private email account, but the trial court also found the company failed to prove a “continuing violation” of the confidentiality provision, and it therefore denied equitable relief. Id. at *6.

On appeal, the company argued that it was entitled to an injunction under the ipso facto clause based on the breach of the confidentiality requirement. The Court of Appeals disagreed, for two reasons. First, there was sufficient evidence to support the trial court’s finding that there was no continuing violation. Second, the court said “a contracting party’s acknowledgment that the other contracting party has a right to equitable relief does not bind judicial actors or require a court to grant the equitable relief ultimately requested.” “Trial courts are afforded discretion in granting equitable relief,” the court explained, and the company “cannot remove that discretion by eliciting a contractual term from Malone authorizing injunctive relief.” Id. at *6 (citing Shoreline Gas).

So the same Court of Appeals has reached the opposite conclusion on this issue? What gives?

Here’s a hint. In both cases, the Court of Appeals affirmed the trial court’s ruling. In Henderson, the trial court granted an injunction, and the Court of Appeals affirmed. In Malone, the trial court denied an injunction, and the Court of Appeals affirmed.

Similarly, in Shoreline Gas, the case cited in Malone, the trial court denied a temporary injunction, and the Court of Appeals affirmed.

You might deduce (or is it induce?) that the rule in non-compete injunction cases is that the party who wins in the trial court wins.

That would be pretty close to accurate, but the truth is a little more complicated. Here’s what I think the “real” rules are:

1. If the trial court grants a temporary injunction to enforce a non-compete, and there is some evidence to support it, the Court of Appeals will usually affirm the injunction and might cite the ipso facto clause as a factor supporting it (although it wouldn’t be necessary, because there would be some evidence to support it anyway).

2. If the trial court denies a temporary injunction, and had some reasonable basis to do so, the Court of Appeals will usually affirm the denial and either say the ipso facto clause had no effect (as in Malone), or say that it was just one factor to consider (as in Wright).

These two rules will apply in the vast majority of cases. And in both scenarios, the Court of Appeals can punt because it doesn’t really have to decide whether the ipso facto clause is dispositive.

In the rare case where the trial court grants an injunction and there is really zero evidence of irreparable injury, then the Court of Appeals might have to bite the bullet and decide whether the ipso facto clause establishes irreparable injury, despite the lack of any evidence. But that will be rare.

So should employers continue to include ipso facto clauses in their non-competes? Well, as much as I hate to include language that I personally think should have no effect, I do include an ipso facto clause in my form non-compete. See The Plain-Language Non-Compete.

For one thing, there’s no real harm in including it. And some judges might consider the clause as a factor, or even find it dispositive, although that would be a mistake.

There’s one more reason I like to include an ipso facto clause in my form non-compete. If I later have to go to court to try to get an injunction enforcing that non-compete, the employee’s stipulation to an injunction can be useful. Why?

Sorry, you can’t expect me to give away all my secrets.

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IMG_4571Zach 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.