Category: Non-Competes

Learning by Rote: Non-Competes for Insurance Agencies

Learning by Rote: Non-Competes for Insurance Agencies

TexasBarToday_TopTen_Badge_VectorGraphicBig insurance companies spend millions on advertising to convince people they provide a better product than their competitors. But the typical home and auto policies consumers buy are written on standard industry-wide forms, so the coverage options are not that different. The same is true for the CGL (Commercial General Liability) policy, the typical liability insurance businesses buy.

There are, of course, differences between insurance companies in financial strength, claims handling, and price. But the coverage they provide is fairly standardized. So it is only a slight exaggeration to say that insurance agents, especially independent agents, are selling an essentially fungible commodity.

So how do insurance agents differentiate themselves? It comes down to two things: personal relationships and customer service. If you can get insurance anywhere, you’re going to prefer an agent you know personally, and you’re going to stick with an agent who provides good customer service.

This creates a legal problem for insurance agencies that want to protect their assets. The law protects an insurance agency’s information in several ways: trade secrets law, enforcement of confidentiality agreements, the “Fiduciary Duty Lite” owed by an employee.

But the most valuable assets insurance agencies “own” are the personal relationships with customers. Accountants call this goodwill. It is literally the “good will” that a customer has towards a business.

People in the insurance industry call this a “book of business,” as if the book can simply be moved from one agency’s shelf to another’s. But the problem for insurance agencies is that the goodwill is usually directed at an individual not at an agency. This means that most of the value in an insurance agency is found in the personal relationships of the individual agents.

The agency must not allow the agents to discover this fundamental truth. If the agents ever found out the agency owner is making profits off their relationships, surely the agents would take to the streets and throw off the yoke of oppression. Insurance agents of the world unite, you have nothing to lose but your chains!

There must be a way for insurance agencies to prevent this and save capitalism as we know it. That’s where non-competes come in.

Enforceability of insurance agency non-competes

The more interchangeable the product, the more important it is to maintain goodwill with your customers. But goodwill is a relationship, not information. So there is really only one legal device to prevent employees from taking goodwill: a non-compete. Naturally, insurance agencies, like many other businesses, will often require their insurance agents to sign non-competes.

The legal problem is that a non-compete is a restraint of trade, and restraints of trade are generally illegal. I say “generally” because most states recognize an exception for non-competes. These states only differ on the size and contours of the exception.

If we had to sum up the Law of Non-Competes in the states that allow them, we could say this: there must be consideration for a non-compete, and the non-compete must be reasonably limited to the purpose of protecting the company’s goodwill with its existing customers.[1]

Just about every state that allows non-competes follows some variation on this theme. When courts find that non-competes are unreasonable, it is usually because they are too broad in time period, geographic area, or the scope of activity they prohibit.

Case study in insurance agency non-competes: Allstate v. Rote

Let’s use a recent case to illustrate how these typical requirements for non-competes can apply to an insurance agency.

In Allstate v. Rote, the agent signed an Exclusive Agency Agreement that contained a one-year non-compete. For one year following her termination, the agent could not solicit any person in competition with Allstate:

(1) who bought insurance from the agency and was an Allstate customer at the time of termination;

(2) who was an Allstate customer at the time of termination and who the agent discovered as a result of her employment with the agency and access to Allstate confidential information; or

(3) from within a one-mile radius of the agency office.[2]

In short, the Allstate non-compete barred the insurance agent from soliciting any insurance customers from within a one-mile radius, or soliciting the agency’s customers anywhere.

The court considered whether this non-compete was enforceable under Oregon law. Like Texas and many other states, Oregon requires that a non-compete be supported by consideration, limited in time and geographic area, and reasonably limited to protecting the company’s interests.[3]

The judge found that the Allstate non-compete met these requirements: the appointment as exclusive agent was sufficient consideration, the non-compete protected Allstate’s legitimate interests in its customer relationships and confidential information, and the one-year time period and one-mile radius were reasonable.[4]

But the judge denied Allstate the injunction it wanted. While the judge granted an injunction to protect Allstate’s confidential information, he declined to enjoin the agent from competing.[5]

Why? Well, as with any injunction, to get an injunction to enforce a non-compete against an insurance agent, it’s not enough for the company to prove the non-compete is enforceable.[6] The company also has to prove that an injunction would be fair.

Non-compete injunctions

Different jurisdictions formulate injunction requirements differently, but in essence it comes down to three words: imminent, irreparable, and equitable. First, there must be an “imminent” threat of harm to the plaintiff, meaning the harm is about to happen. Second, the threatened injury must be “irreparable,” meaning money damages are inadequate to compensate the plaintiff. Third, the injunction must be “equitable” and serve the public interest.

“Equitable” is just a fancy legal word for “fair,” so let’s say the third requirement is that the injunction must be fair to the defendant and to the public.

As a litigator who reads a lot of injunction cases (you can read about some non-compete injunction cases here), I should warn you to take these theoretical requirements with a large grain of salt. For example, courts often water down the “irreparable injury” requirement so much that it becomes almost meaningless. For example, in the Rote case, the judge had to follow Ninth Circuit law, which apparently says that a breach of a non-compete causes irreparable harm “[b]ecause the harm is intangible and difficult to quantify.”

Time out for a quick rant. It always bugs me when courts say this kind of thing. It is just wrong to suggest that the harm resulting from breach of a non-compete is always “intangible” and “difficult to quantify.” In many cases, the harm will be quite tangible and relatively easy to quantify: the amount of profits the company lost as a result of its customers buying a product from the former employee rather than the company.

Now back to the requirements for injunctions. Judges also vary widely in how much weight they give the third factor: equity and the public interest. Courts often brush aside these considerations with a rote statement to the effect of “enforcing reasonable non-competes is in the public interest, therefore an injunction here will not disserve the public interest.”

But some judges, like the one in Allstate v. Rote, take this requirement more seriously. As to Allstate’s demand that Rote cease operating out of her former agency location, Judge Hernandez said “[t]he controlling consideration is the harm that Allstate would suffer from the erroneous denial of a preliminary injunction compared to the harm Rote would suffer from the erroneous grant of such relief.” Considering the fact that Rote had signed a five-year lease at her office location, the judge found that granting the injunction would cause Rote “severe financial loss and ability to sustain her profession.” This tipped the “balance of equities” in Rote’s favor.[7]

So, Allstate v. Rote shows us that even when an insurance agency non-compete is reasonably limited, the judge may decline to enjoin an agent from competing, especially where an injunction would cause the agent significant financial hardship.

Fact issues in insurance agent non-compete cases

Lawyers who enforce non-competes can sympathize with Allstate’s counsel. They are all too familiar with the employee’s lament of “judge, how can I possibly make a living and put food on my family’s table if you enforce this non-compete?” It’s an occupational hazard. But that’s not the only problem for an insurance company, or any company, that tries to enforce a non-compete.

There is also the “fact issue” problem. Insurance company non-competes tend to be especially susceptible to this. Often the insurance company will do what Allstate did and limit the non-compete to “solicitation” of customers. This makes it more likely the non-compete will be found reasonable and, therefore, enforceable.

The problem is that whether the insurance agent “solicited” the agency’s customers is often a fact in dispute.

Let me put it in terms lawyers will understand. Let’s say you’re a litigator who has seven active litigation matters. You leave your law firm to go to another firm. You call each of your seven active clients say, “I just wanted to let you know I’ve joined the firm of Burr & Hamilton; you are free to decide whether to stay with my old firm or not.” Has the lawyer just “solicited” the clients?

Different people will interpret “solicit” differently, plus there may be a dispute about exactly what was said on each phone call.

This was the issue in Allstate v. Sidakis. In that case, Allstate claimed that the defendants solicited Allstate customers in violation of a non-compete. Allstate even produced signed statements from customers claiming they were solicited. But the defendants denied this, and the court found that the conflicting testimony presented a fact issue for trial.[8]

This problem is compounded by the fact that customers, who don’t want to be treated like property and told where they can and can’t buy insurance, are usually not inclined to testify in support of the insurance company.

Put all this together and you get fact issues. That means the judge cannot grant summary judgment, and the case has to go to trial. And a trial means more time and money. A lot of money (I explain how much in this video).

Good for lawyers. Not necessarily good for insurance companies, agencies, and agents. They’re already spending a lot of money on all those commercials.

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head-shot-photo-of-zach-wolfeZach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Austin, Houston, and The Woodlands.

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

[1] Please don’t take this generalization as legal advice for your situation; consult with a lawyer about the law in your state.

[2] Allstate Ins. Co. v. Rote, No. 3:16-cv-01432-HZ, 2016 WL 4191015, at *1-2 (D. Or. Aug. 7, 2016) (unpublished).

[3] Id. at *4 (citing Nike, Inc. v. McCarthy, 379 F.3d 576, 584-85 (9th Cir. 2004)).

[4] Id.

[5] Id. at *7.

[6] In Texas, there are some cases suggesting that the traditional common law requirements for an injunction do not apply to an injunction to enforce a non-compete, which is governed by statute. This is currently an open issue under Texas law.

[7] The judge also cited the important factor that there was no evidence that Rote had taken any business from Allstate by operating from her former agency location. Id. at *6. Perhaps the equities would have tipped back towards Allstate if Rote had been actively poaching Allstate customers.

[8] Allstate Ins. Co. v. Sidakis, No. 13-CV-7211, 2016 WL 556869, at *5, 8 (E.D.N.Y. Feb. 10, 2016) (unpublished).

Head First Into the Abbiss: Temporary Injunction Rulings in Recent Texas Non-Compete Cases

Head First Into the Abbiss: Temporary Injunction Rulings in Recent Texas Non-Compete Cases

Offer evidence of “imminent harm” and “irreparable injury,” even if judges don’t always require it

In a non-compete lawsuit, the temporary injunction hearing is often the key event, for two reasons.  First, a reasonable time limit for the non-compete is usually around the same time that the case takes to go to trial. So, if the judge enters a temporary injunction enforcing the non-compete until trial, it can be practically the same as a permanent injunction.

Second, a temporary injunction puts the company in the driver’s seat in settlement negotiations. Most employees will have to make a deal with the company, because otherwise they won’t be able to make a living.

Conversely, if the judge denies a temporary injunction, then the company is probably never going to get any injunction. That means the company is limited to seeking damages. This is significant in a Texas non-compete case, because if the non-compete is overbroad as written, the company can’t get damages either.[1]

So the stakes are high at the temporary injunction hearing. That means the lawyers better be prepared to address the enforceability of the non-compete and the traditional requirements for a temporary injunction, because some judges still care about those things.

1. A temporary injunction should be denied if the employee has not competed in the geographic area he was responsible for at the first company

In Cameron International v. Abbiss, the judge denied a temporary injunction because the employee had not breached the non-compete as limited to a reasonable geographic area.[2]

Abbiss signed a one-year non-compete with his employer, Cameron. He later went to work for a competitor, FMC, as its General Manager for the Middle East. Cameron sued Abbiss in federal court and sought a preliminary injunction.

The court found the non-compete as written was overbroad. A reasonable geographic limit would be Oman and Yemen, the court said, because (1) those were the countries Abbiss was responsible for during his last two years of employment, and (2) the evidence did not support Cameron’s claim that Abbiss received confidential Cameron information regarding the entire Middle East. The court found that much of the information Abbiss received at the meeting at issue was either publicly available or was available to employees who did not have non-competes.

The question, then, was whether to enter a preliminary injunction barring Abiss from competing in Oman and Yemen, the reasonable geographic area. The court said no, because (1) there was no evidence Abbiss had competed or intended to compete in Oman or Yemen, and (2) the confidential information Abbiss obtained regarding bids in other Middle East countries was more than six months old and likely stale.

In short, the court in Abbiss denied a temporary injunction because there was no evidence the employee breached or intended to breach the non-compete within the geographic area the court found was reasonable.

2. Judges are not always strict about the “irreparable injury” requirement

In Fantastic Sams v. Mosley, Mosley opened a competing hair salon in violation of his two-year non-compete, which covered a five-mile radius from a Fantastic Sams franchise in Cypress (the Houston suburb, not the Mediterranean island).[3]  After finding the non-compete was reasonable, the judge found that Mosley’s violation of the non-compete was likely to cause irreparable injury:

Fantastic Sams . . . argued the existence of Mosley’s nearby salon, which offers nearly identical hair care services to Fantastic Sams, prevents Fantastic Sams from licensing a new franchise in the area. The court also notes that the Agreement actually contains a provision that requires Mosley to concede that violations of the Agreement constitute irreparable harm to Fantastic Sams. The court agrees with Fantastic Sams that Mosley’s continued operations of a nearby salon, in violation of the Agreement, hurts other franchisees, poses a risk of loss of goodwill, and inhibits the opening of new Fantastic Sams franchises in the area. All of these injuries cause irreparable harm to Fantastic Sams as a whole, and that harm cannot be fully remedied with damages.

“Identical hair care services.” I love that part. I can only assume there was testimony that both salons offered a unique proprietary combination of shampooing, cutting, and blow drying. But I digress.

pexels-photo-163569
Does this look like “irreparable injury”?

The passage above from Fantastic Sams is typical of cases granting a temporary injunction to enforce a non-compete. Judges often apply the “irreparable injury” requirement loosely, especially when there is a clear violation of the non-compete.

Yes, there was a contractual stipulation to irreparable harm, but surely that can’t be dispositive. Almost every non-compete has a clause like this, so allowing it to substitute for actual evidence of irreparable injury would effectively abolish the irreparable injury requirement in non-compete cases.

And I don’t read Fantastic Sams as saying that a contractual stipulation, by itself, is sufficient. My practical takeaway from the case, and others like it, is that it’s easier to clear the “irreparable injury” hurdle when the judge sees that the defendant is behaving badly by blatantly breaching a reasonably limited non-compete.

3. Companies should present evidence of imminent harm, not just an argument about “inevitable disclosure”

While courts don’t always apply the “irreparable injury” requirement strictly, DGM Services v. Figueroa shows that the company trying to obtain a temporary injunction still needs to offer evidence that harm has already happened or is about to happen.[4]

In that case, DGM’s president, Petillon, testified that Figueroa received confidential financial information on budgets, revenues, and costs while working for DGM. He expressed concern that Figueroa would use his knowledge to undercut DGM’s prices and gain an unfair advantage. But Petillon did not know if Figueroa had actually provided confidential information to his new employer, GCC, or whether DGM had lost any customers to GCC since Figueroa had left.

The trial court denied a temporary injunction, stating that DGM did not prove imminent harm. On appeal, DGM argued that proof of violation of a non-compete creates a presumption of probable, imminent, and irreparable harm.

The Houston Court of Appeals disagreed. Under recent Texas Supreme Court cases, the applicant for a temporary injunction has the burden to prove these elements to obtain a temporary injunction. Therefore, the Court of Appeals declined to hold that breach of a non-compete creates a presumption of harm that relieves the plaintiff of its burden to offer evidence. DGM only established a “fear of possible injury,” so the trial court was within its discretion to deny the injunction.

DGM also argued that the “inevitable disclosure doctrine” relieved it of the burden of offering evidence of imminent harm, citing state and federal cases applying various versions of it. The Court of Appeals disagreed, finding that Texas courts have not adopted the doctrine, and that it is not a blanket rule applicable to all nondisclosure agreements. DGM was still required to offer evidence of imminent harm.

You can find a lot of articles (like this one) on the inevitable disclosure doctrine, so I won’t go into great detail. Essentially, it is the idea that a court can enjoin a company’s former employee from working for a competitor, even if the employee hasn’t done anything wrong yet, on the theory that the employee will “inevitably” disclose his knowledge of the company’s confidential information to the competitor.

I don’t like the idea of an inevitable disclosure “doctrine.” These are fact-intensive cases that should be decided based on the evidence in each case. Talking about some general “doctrine” distracts from the real issues, which should be imminent harm and irreparable injury.

If the inevitable disclosure doctrine is merely the common-sense notion that a former employee who is working for a competitor is in a position to use the company’s confidential information, then it’s fine. But if the inevitable disclosure doctrine means that the company doesn’t have to offer any evidence of imminent harm, then it is wrong. The DGM case got this point right.

The recent BM Medical case was similar.[5] BM Medical argued that its former employee, Turner, had access to its confidential information such as client lists and prices, and that Turner would be able to use his knowledge to “undersell” BM Medical. But Turner testified that he did not access any confidential information after his termination, that he did not solicit any BM Medical clients, and that the only BM Medical client who became a client of his new company was a friend he knew before going to work for BM Medical.

Like the plaintiff in DGM Services, BM Medical argued that Turner had its confidential information, was working for a direct competitor, and intended to use the information. But like the court in DGM Services, the court in BM Medical disagreed. It held that the trial court was within its discretion to deny a temporary injunction based on the evidence that Turner had not used any confidential information and was not soliciting BM Medical clients.

Lessons from these recent Texas non-compete injunction cases

If you represent the company asking for a temporary injunction to enforce a non-compete, you can cite the contract’s stipulation that irreparable injury is presumed. You can cite the “inevitable disclosure” doctrine. You can cite cases that get confused and say that evidence of imminent harm shows that the injury is “irreparable.”

But ideally, you should come to the hearing prepared to offer actual evidence that the employee has already caused harm to the company or is about to do so, and that the harm cannot be adequately compensated by damages. That way, you don’t have to rely on debatable legal arguments the judge might not find persuasive.

The best way to show imminent harm in a non-compete case is to show that your client has already lost customers to the competitor the former employee is now working for. The best way to prove irreparable injury is to hope the judge doesn’t take the irreparable injury requirement too seriously.

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head-shot-photo-of-zach-wolfeZach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Houston, Austin, and The Woodlands.

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

[1] See Tex. Bus. & Com. Code 15.51(c) (stating that if the non-compete is not reasonably limited in time period, geographic area, and scope, then the court must reform the non-compete but may not award damages occurring prior to reformation).

[2] Cameron Int’l Corp. v. Abbiss, No. H-16-2117, 2016 WL 6216667 (S.D. Tex. Oct. 25, 2016).

[3] Fantastic Sams Franchise Corp. v. Mosley, No. H-16-2318, 2016 WL 7426403 (S.D. Tex. Dec. 23, 2016).

[4] DGM Servs., Inc. v. Figueroa, No. 01-16-00186-CV, 2016 WL 7473947 (Tex. App.—Houston [1st Dist.] Dec. 29, 2016, no pet.) (mem. op.).

[5] BM Med. Mgmt. Serv., LLC v. Turner, No. 05-16-00670-CV, 2017 WL 85423 (Tex. App.—Dallas Jan. 10, 2017, no pet. h.).

Horizon Case Addresses Causation Conundrum in Departing-Employee Litigation

Horizon Case Addresses Causation Conundrum in Departing-Employee Litigation

Oral argument in Horizon Health v. Acadia Healthcare illustrates difficulties with proving lost profits damages when employment is at-will

Last week I wrote about a new Texas Supreme Court opinion that had to draw the line between sexual harassment and sexual assault. Just days later, the Texas Supreme Court confronted an even more difficult issue in oral argument in Horizon Health v. Acadia Healthcare: how to draw the line between reasonable assumption and speculation when an expert witness testifies about lost profits damages in a departing-employee case.

This is a difficult issue, because the typical departing-employee case involves at-will employment. Let’s assume a group of employees does all kinds of bad things before leaving to go to work for a competitor. And let’s assume the employer lost sales after the group left. Those facts are relatively easy for a jury to understand.

But this leaves out a critical issue that is harder for the average person to grasp: causation.  It’s not enough to prove the defendants did bad things and the plaintiffs were damaged. You have to prove that the bad things caused the damage. And you have to quantify the damage.

Let’s say the bad conduct is soliciting a key employee to join a competitor, and the damage is the loss of sales the key employee would have made for the company if she had not been solicited. The problem for the plaintiff is obvious: if the key employee is an at-will employee, she could have left the company at any time regardless of whether she was solicited. How do you quantify the amount of lost profits caused by the wrongful solicitation?

That, in simplified form, is the problem confronting the Texas Supreme Court in Horizon Health v. Acadia Healthcare. I call this the Causation Conundrum for departing-employee cases.

Facts of Horizon v. Acadia: the distilled version

Horizon was a somewhat complex case with multiple defendants, numerous causes of action, and a 55-page jury charge (see Court of Appeals opinion here). But the basic facts, in simplified form, follow a familiar pattern:

  • Horizon managed mental-health programs for hospitals.
  • Four of Horizon’s executives, the Saul group, began negotiating to join a Horizon competitor, Acadia, while they were still working for Horizon.
  • While still employed by Horizon, the Saul group solicited John Piechocki, a successful Horizon salesman, to work for the competitor.
  • The Saul group and Piechocki left Horizon to work for Acadia.
  • Before leaving Horizon, the Saul group said things in their emails that must have made their trial lawyers cringe later. Our departures will leave Horizon “dead,” they said, and our business strategy at Acadia will be “hurting Horizon early and often.”
  • The Saul group also did things that would not look good to the jury. Saul, for example, copied a massive amount of Horizon files from his work computer to an external hard drive before leaving Horizon.[1]

Given these facts, Horizon’s lawyers had a lot to work with on liability. But how could they prove the Saul group caused damage to Horizon by bringing Piechocki to the new company? And how could they quantify that damage?

Startup Stock Photos
Emails about “hurting Horizon early and often” certainly didn’t help the defendants at trial

These challenges were compounded by a couple pesky facts. First, Horizon’s profits continued to go up after the employees departed, even exceeding Horizon’s own targets. Second, there was no evidence that any existing Horizon customer left and went to Acadia.

How could Horizon prove lost profits given all these difficulties? The answer is that Horizon tried to prove causation and damages the old-fashioned way: they hired an expert.

Horizon’s expert dares to pose hypotheticals and make assumptions

Horizon designated Jeff Balcombe, a qualified CPA, to testify on damages. Balcombe’s assignment was to quantify Horizon’s future lost profits resulting from the loss of Piechocki. In the words of the Court of Appeals:

Balcombe testified as to the “lost production” damages Horizon suffered as a result of the individual defendants’ wrongful actions. In doing so, he attempted to determine what would have happened but for the wrongful actions—as opposed to what actually happened—by considering (1) how long Piechocki would have remained an employee of Horizon but for the alleged wrongful conduct, (2) how many contracts Piechocki would have sold “but for being an employee of Horizon,” and (3) what the average profit for each of those contracts would have been had he remained with Horizon.[2]

The court’s interjection “as opposed to what actually happened” is dripping with skepticism. But in fairness to Horizon, let’s pause here to consider the nature of causation and damages in a lost profits case involving departing employees.

Proving lost profits damages necessarily requires entering a hypothetical world. To prove how the defendants caused your company to lose profits, you must ask the hypothetical question “what amount of profits would we have made but for the defendants’ wrongful conduct?” There is no other way to do it. So when Horizon’s expert tried to figure out what would have happened, he was doing his job.

The harder part for the damages expert is deciding what assumptions to make. Balcombe based his lost profits analysis on three assumptions:

  1. “Balcombe analyzed the average amount of time Horizon retained its higher-level employees and ‘conservatively elected to assume’ that Piechocki would have stayed at Horizon two or four more years but for the alleged wrongful conduct.”
  1. “Piechocki would have sold six contracts in each year he stayed, up to four years, but for the wrongful conduct because other Horizon salespeople sold four contracts per year.”
  1. “He concluded that $247,000 per year for each contract was ‘a conservative and reliable figure for a mature contract price.’”[3]

This is where the Court of Appeals thought the damages expert went wrong. “We conclude that Balcombe’s opinion was too speculative based on an analytical gap between the data and his opinion; thus, it was no evidence of lost profits suffered by Horizon.” For example, the assumption that Piechocki, an at-will employee, would have stayed employed by Horizon was “nothing more than speculation.” Experts are allowed to make assumptions, but the Court of Appeals found that Balcombe’s factual assumptions were “unsupported” and “not admitted into evidence.”[4]

Wait a minute. Does this mean lost profits damages are never recoverable in a case based on solicitation of an at-will employee? Is the Court of Appeals saying a damages expert is never allowed to make assumptions about how long an at-will employee would have stayed at a company? And does the plaintiff have to offer evidence during the trial to support every factual assumption made by the damages expert?

Surely the Court of Appeals did not mean to go that far. But where to draw the line? That is what the Texas Supreme Court will have to decide.

Fortunately I have the answers to these difficult questions

Does the fact that a wrongfully-solicited employee was also an at-will employee legally bar the company from obtaining lost profits damages? The answer has to be no. That the employee could have left at any time is certainly a relevant fact for the jury to consider, but it can’t mean that lost profits damages are never recoverable in such a case.

So, if lost profits damages are available in such cases, is it legally impermissible for a damages expert to make assumptions about how long a solicited employee would have stayed at the company?

Some might argue that making an assumption about how long an employee would have worked for the company is always speculative, and therefore impermissible. How can an expert know with absolute certainty how long an at-will employee would have stayed?

The answer, of course, is that he can’t. But absolute certainty is not required. The Texas Pattern Jury Charge asks the jury to decide the amount of lost profits “that, in reasonable probability, will be sustained in the future.” Reasonable probability is the standard.

SAMSUNG CAMERA PICTURES
There is always some hypothetical element to the calculation of lost profits damages

So, even if the employment is at-will, a damages expert can make assumptions based on reasonable probability. That much is clear. But what assumptions?

Again, the question almost answers itself. The assumptions must be reasonable and must be supported by some evidence. No one would argue that an expert can base a damage calculation on unreasonable assumptions. And a damages expert should not be allowed to assume facts that have no evidence to support them.

A harder question is whether the facts assumed by the expert must be offered in evidence at trial. Texas Rule of Evidence 703, like the corresponding Federal Rule, allows an expert to reasonably rely on facts he has been made aware of, even if those facts are not admissible. But the Court of Appeals in Horizon was troubled by the fact Balcombe’s underlying information was not admitted into evidence.

The Texas Supreme Court also seemed troubled. In oral argument, one of the justices asked whether there was any evidence other than the expert testimony to support the amount of damages found by the jury. The Court of Appeals assumed the answer was no. But Horizon’s counsel argued to the Supreme Court that the answer was yes.

So perhaps the Texas Supreme Court will sidestep the entire expert testimony issue and find that there was other evidence sufficient to sustain the damages verdict.

It’s hard to predict what this Texas Supreme Court will do in a departing-employee lawsuit. This is a court that likes defendants and doesn’t like big speculative damage awards (see Southwestern Energy for example). But this is also a court that likes employers and non-competes.

If I had to predict, I would bet that the court’s aversion to speculative damage awards will outweigh its warm fuzzy feelings for employers, meaning a win for the defendants on the lost profits damages issue.

But it is a conundrum.

*UPDATE: The Texas Supreme Court issued its opinion on May 26, 2017, ruling that the evidence was legally insufficient to support any award of lost profits. See my analysis here.

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head-shot-photo-of-zach-wolfeZach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Houston, Austin, and The Woodlands. He can’t remember the last time he wrote a post with as many rhetorical questions as this one.

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

[1] Acadia Healthcare Co. v. Horizon Health Corp., 472 S.W.3d 74, 79-82 (Tex. App.—Fort Worth 2015, pet. filed).

[2] Id. at 88.

[3] Id. at 88-89.

[4] Id. at 89-90 (emphasis added).

The Most Effective Form of Non-Compete in Texas (or Anywhere)

The Most Effective Form of Non-Compete in Texas (or Anywhere)

I previously wrote about the second most effective form of non-compete here. This kind of non-compete is drafted as narrowly as possible to maximize the chance that it will be enforced.

So what is the most effective form of non-compete?

The most effective form of non-compete is a happy employee who doesn’t want to leave the company.

If you’re an employer that’s probably not the answer you wanted to hear. You might even feel cheated by my headline.

Most companies that employ a sales force will not like this advice. But the problem is that companies who think they can solve the problem with a non-compete are probably (1) underestimating the value of happy employees and (2) overestimating the effectiveness of a non-compete.

I’m not a great businessman, so I don’t have any special insight about the value of happy employees, but I can observe what successful business people have said and done. My dad, for example, built a successful software consulting business that literally started in his living room. How? He recruited and retained top-notch talent by focusing on the quality of life of his employees. You might even say I got to go to college because my dad’s company had happy employees.

Another source is a businessman I don’t know personally, but he seems to have done alright. Richard Branson has said: “Take care of your employees, and they’ll take care of your business. It’s as simple as that.” In a similar vein, he said: “Train people well enough so they can leave. Treat them well enough so they don’t want to.”

Frankfurt, Germany - May 17: Richard Branson, Founder And Presid
Sir Richard Branson

So, while I don’t claim to be a business expert, I know that business people who keep their employees happy seem to do pretty well.

Non-competes, on the other hand. Those, I know a little about.

The legal problem with a non-compete is that there is almost always a dispute over whether it’s enforceable. The first thing I do when a client comes to me with a non-compete is to evaluate its enforceability. As I explained here, there are five things I look for in the typical Texas non-compete to determine if it is legally enforceable.

These five things have something in common: often the answer will depend on resolution of disputed facts. In litigator lingo, these five things often raise “fact issues,” meaning the case may have to go to trial before the judge decides if the non-compete is enforceable.  As I explain in this video, that means time and money.  A lot of time and money.

So how can you hold on to your best employees instead of ending up in litigation with them? Regardless of what kind of company you have, I can guarantee that you have two kinds of sales people working for you: above average and below average. Now, ask yourself these questions.

If a below-average sales person wants to leave the company and try to compete with you, do you really care?

If an above-average sales person wants to leave the company to work for a competitor, why?

There is always a reason. If money is an issue, then why is a competitor willing to pay the employee more? Is the competitor miscalculating and overestimating the value of the employee? Does the competitor recognize value that you may be underestimating?

If money isn’t the issue, what are you doing that is making your above-average employees unhappy? Is their boss a jerk? Do you give them enough independence? Do they feel like they can go on vacation?

Some hard-nosed employers will think me naïve. You don’t understand my industry, they will say.  It’s intensely competitive. Everyone is fighting for the same limited group of customers. It’s cutthroat. Sales people only care about money and will leave their employer at the drop of a hat for the promise of a bigger paycheck. I can’t afford to invest a lot of time and money in training my people and helping them develop customer relationships, only to have them turn around and leave, taking customers with them.

So let me get this straight. First, you’re saying your business is very competitive and requires skilled employees. Second, you’re saying that developing high performing employees takes time, money, and effort. Third, you’re saying that if you require your employees to sign non-competes, you can hold on to your best employees and customers.

To which I respond, who is being naïve?

p.s. I’m beta testing my new YouTube channel called “Non-Compete News.” Please check it out here and give me some feedback! Official rollout coming soon.

____________________________________________________

head-shot-photo-of-zach-wolfeZach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Houston, Austin, and The Woodlands.

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 Non-Compete Case Teaches Importance of Providing Specialized Training

Recent Non-Compete Case Teaches Importance of Providing Specialized Training

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Proving the employee received confidential information is not the only way to enforce a non-compete

A lawyer recently called me for some free advice on non-competes. It came down to a question of how to make an employee non-compete enforceable when the information the employee would receive was not all that confidential. This presents a problem because, as I explained here, the typical way to make a Texas non-compete enforceable is to tie it to an agreement to provide the employee confidential information.

This experience presented some interesting questions. First, how am I going to maintain a profitable law practice by giving out free advice? Maybe I can follow the philosophy of First CitiWide Change Bank, a bank that specializes in making change: “All the time, our customers ask us, ‘How do you make money doing this?’ The answer is simple: Volume.”

boat-teamwork-training-exercise-39621
Specialized training is another way to support a non-compete

Second, what is the best way to make an employee non-compete enforceable in Texas other than a confidentiality agreement? The answer is a non-compete tied to specialized training, the important but sometimes neglected stepchild of the typical non-compete tied to a confidentiality agreement.

Neurodiagnostic Tex v. Pierce found a non-compete enforceable where the employee received specialized training

The recent Texas case Neurodiagnostic Tex v. Pierce shows that an employer’s agreement to provide an employee specialized training—like an agreement to provide confidential information—can also be used to make a non-compete enforceable.

The Tyler Court of Appeals held in Neurodiagnostic that an agreement to provide specialized training met the statutory requirement of an “otherwise enforceable agreement” where:

1. The employer actually provided the promised training (paying for in-house and third party training).

2. There was evidence that the training was specialized (the employee obtained two new board certifications relating to surgical assistance).[1]

This holding should not be controversial. Texas courts have already cited specialized training as an example of an interest worthy of protection by a non-compete.[2] But tying enforceability of a non-compete to specialized training raises some unanswered questions.

Questions raised by tying a non-compete to specialized training

1. Can an agreement to provide ordinary training support a non-compete, or does it have to be specialized training? A non-compete must be “designed to enforce the employee’s consideration or return promise in the agreement.” The Neurodiagnostic court reasoned that there was a “clear nexus” between investing in the specialized training and preventing the employee from using the specialized training to benefit a subsequent employer. But if the training is not specialized, enforcing the non-compete would arguably offend the longstanding Texas principle that an employee is free to use her “general know-how” in competing with a former employer.[3]

2. Is it enough for the employer simply to recite in the agreement that the training is specialized? Especially after Neurodiagnostic, smart lawyers who draft non-competes will include a statement that the training is specialized. Is that enough, or does the judge need to look behind the agreement at the facts? There was sufficient evidence in Neurodiagnostic that the training was specialized, so the court did not have to confront this issue.

bodybuilder-weight-training-stress-38630
Would this qualify as “specialized training”?

3. Does it matter whether the training was actually specialized? The employer will always think the training is “specialized,” and the agreement will usually say the training is specialized, but does it matter what the evidence shows? The Neurodiagnostic opinion implies the answer is yes: The reason the court found the employer’s interest “worthy of protection” was that there was at least some evidence that the training really was specialized.

4. Who decides whether the evidence proves the training was specialized, the judge or the jury? If there is conflicting evidence, does the issue go to the jury? These procedural questions get less attention, but as a lawyer who litigates non-competes, I find them the most interesting. In Neurodiagnostic, it was undisputed that the employee received certain training and certifications, and the Court of Appeals found that the evidence conclusively satisfied the “otherwise enforceable agreement” requirement. But what if the evidence had been conflicting? If the trial court denies summary judgment on enforceability of the non-compete, doesn’t the underlying fact issue need to be submitted to the jury?

parachute-skydiving-parachuting-jumping-128880
Now this looks like specialized training

These questions about specialized training are, of course, analogous to the questions that arise when a non-compete is tied to a confidentiality agreement. Is it conclusive that the agreement recites that the information is confidential? Does it matter whether the information was actually confidential? Can this present a fact issue that must go to the jury?

At press time, Texas courts had not definitively answered these questions.

Employers: enforceability is nice, but don’t forget damages

Enforceability is not the only issue in non-compete litigation. Even if the non-compete is enforceable, and even if the employee violates the non-compete, the employer suing to enforce the non-compete still has to prove the breach of the non-compete caused damages. As in most kinds of litigation, there is a danger that proof of damages can  become an afterthought in non-compete litigation.

In Neurodiagnostic, the court found there was no evidence that the employee (Pierce) and the second employer (Synergy) caused any damage to the first employer (Neurodiagnostic) because:

  1. The mere fact that Synergy hired Pierce and competed with Neurodiagnostic was not evidence of damages, where the evidence did not show that Pierce was the technician on any case Neurodiagnostic lost.
  1. Evidence of the profits that Synergy made was not evidence that the breach caused damage to Neurodiagnostic.[4]

Wait a minute, you say. What was the point of the court spending all that time deciding whether the non-compete was enforceable, if there was no evidence of damages? Why didn’t the court just cut to the chase and say “no damages, case dismissed”?

crash-test-collision-60-km-h-distraction-163016
Don’t forget evidence of damages

Keep in mind that damages are not the only remedy for breach of a non-compete. The employer can also obtain an injunction barring the employee from competing. So, the fact that there was no evidence of damages was not the end of the story. The Court of Appeals sent the case back to the trial court to determine the reasonable scope of the non-compete and whether to enter an injunction.

Lessons Learned

So what does Neurodiagnostic teach Texas lawyers who handle non-compete litigation? If you represent the employer trying to enforce a non-compete that is tied to confidential information or specialized training, be sure to find and offer evidence that:

  1. The employer actually provided the promised confidential information and/or specialized training to the employee
  1. The information was actually confidential, or the training was actually specialized;
  1. The employee competed with the employer and caused damage by taking business that would have gone to the employer.

If you want some ideas on how to prove (or disprove) these points, give me a call. I may even tell you for free.

______________________________________________________

head-shot-photo-of-zach-wolfeZach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn has offices in Austin, Houston, and The Woodlands. He has received specialized training on how to use phrases like “Comes now, Plaintiff” and “Wherefore, premises considered,” sometimes even in ALL CAPS.  

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

[1] Neurodiagnostic Tex, LLC v. Pierce, No. 12-14-00254-CV, 2016 WL 6426830, at *5-7 (Tex. App.—Tyler Oct. 31, 2016).

[2] See, e.g., Alex Sheshunoff Mgmt. Servs., L.P. v. Johnson, 209 S.W.3d 644, 655 (Tex. 2006) (non-compete became enforceable once the employer provided the promised confidential information and specialized training).

[3] See, e.g., Evan’s World Travel, Inc. v. Adams, 978 S.W.2d 225, 231 (Tex. App.—Texarkana 1998, no pet.) (“General skills and knowledge developed through the course of employment are not the type of interest which justifies protection under a restrictive covenant”).

[4] Neurodiagnostic, 2016 WL 6426830, at *12.

Recent Case Shows How to Enforce the Typical Texas Non-Compete

Recent Case Shows How to Enforce the Typical Texas Non-Compete

Some Basic Issues in Texas Non-Compete Law Remain Unresolved

First of all, I don’t understand why the Texas non-compete statute says “geographical” when “geographic” would do. More about that later.

The typical Texas non-compete follows a predictable pattern, and there are thousands of them in circulation in Texas. As I explained here, as a Texas litigator I look for five key things to decide whether a typical Texas non-compete is enforceable.

But the answer is often cloudy. The recent case Orchestratehr, Inc. v. Trombetta shows that basic questions about Texas non-compete law remain unanswered, and that minor factual distinctions can make all the difference to whether a Texas non-compete will be found enforceable. As we will see, this makes witness preparation especially critical in a Texas non-compete lawsuit.

Thomas Jefferson
Can we get back to non-compete law? Please?

Most Texas lawyers who deal with non-competes know the two basic requirements for enforceability: (1) the non-compete must be “ancillary to an otherwise enforceable agreement,” and (2) the non-compete must be reasonable in time period, geographic area, and scope. But lawyers who don’t have practical experience actually litigating these issues can get tripped up easily.

“Ancillary to an Otherwise Enforceable Agreement”

Whether the non-compete is “ancillary to an otherwise enforceable agreement” often comes down to whether the employee admits that (a) he needed confidential information to do his job, and (b) he received confidential information. Why? Here is how it usually plays out:

  1. The employer’s agreement to provide confidential information to the employee can be an “otherwise enforceable agreement” supporting a non-compete, if the employer actually provides the confidential information.[1]
  1. If the confidentiality agreement contains no express promise by the employer to provide confidential information (which, inexplicably, is sometimes the case), the question is whether there is an implied promise to provide confidential information.[2]
  1. There is an implied promise if the nature of the work to be performed by the employee requires providing him confidential information.[3]
  1. The confidentiality agreement, drafted by the employer, will typically define confidential information to include virtually every kind of information the employee receives in the course of employment.
  1. The typical Texas non-compete will have a time period of one to three years. Despite the requirement of a reasonable geographic limitation, it will often have no express geographic limitation. Sometimes the non-compete will be limited to the employer’s existing customers, or the customers the employee personally dealt with.

It is safe to say this scenario—or some variation of it—has occurred in thousands of Texas lawsuits. So Texas courts by now must have a standard answer to whether the non-compete is enforceable in this scenario, right?

Well, not really. Even this cookie-cutter scenario raises at least two unresolved legal issues, and an important factual issue that varies from case to case.

Legal Issue #1: Does it Matter if the Information is Not Really Confidential?

The first unresolved legal issue is this: does it matter whether the information the employer provided the employee was actually confidential? The employer will argue that it is sufficient for the agreement to define the information as confidential and will cite this statement from the Texas Supreme Court:

Concerns that have driven disputes over whether a covenant is ancillary to an otherwise enforceable agreement—such as the amount of information an employee has received, its importance, its true degree of confidentiality, and the time period over which it is received—are better addressed in determining whether and to what extent a restraint on competition is justified.[4]

In other words, the degree of confidentiality of the information goes to the reasonableness requirement, not the “ancillary” requirement. Yet, despite this statement, it remains clear that a confidentiality agreement is only an “otherwise enforceable agreement” if the employer actually provides confidential information.

a man wearing a suit showing a document with the text confidenti
A non-compete is enforceable if it is stamped “Confidential” at the top. Just kidding. Sort of.

In the recent Orchestratehr case, the employee made the typical argument that the non-compete was not ancillary to an otherwise enforceable agreement because the employer did not give the employee any actual confidential information. Although the court implicitly accepted the employee’s legal premise, it rejected the employee’s argument based on two facts. First, the agreement had a typical clause that defined virtually everything as the employer’s confidential information.[5] Second, the employee admitted in his deposition that the information was confidential.[6]

Obviously, the second reason deserves more weight than the first. The fact that the agreement defines virtually all information as confidential should receive little, if any, weight. If employers could satisfy the “ancillary” requirement simply by reciting the right “magic words,” it would render the requirement meaningless.

The employee’s admissions, on the other hand, are hard to ignore. At the least, these admissions raised a fact issue for the jury on whether the employee actually received confidential information. This shows the importance of witness preparation in non-compete cases.

Factual Issue: Did the Employee Testify That He Received Confidential Information?

As Orchestratehr shows us, whether a non-compete meets the “ancillary” requirement can often turn on whether the employee admits that the information he received was confidential. This makes witness preparation critical.

If you represent an employee who signed a typical non-compete tied to a confidentiality agreement, you need to thoroughly debrief the employee early in the case about the kind of information needed to do the job and the type of information the employer actually provided. Go into detail, and review the documents (if available). It’s important to do this early so you can answer two crucial questions.

First, if the non-compete does not have an express agreement to provide confidential information to the employee, did the nature of the work required confidential information? If the answer is no, you need to prepare your client to say so and to explain why.

Second, can the employee reasonably contend that the information he received was not really confidential? If the answer is no, then don’t waste your time and effort trying to argue the employer failed to provide confidential information. Ultimately, a half-hearted or frivolous argument that the information was not confidential will not help your client.

But the answer is often yes. Customer lists, customer information, and prices are the information most commonly claimed to be confidential. I sometimes call this kind of information “soft” trade secrets. Employers always think this information is extremely valuable and confidential. In reality, it is often readily ascertainable by competitors. The real value is usually in the personal relationships the employee has with his customers.

Don’t get me wrong. There are legitimate cases where these “soft” trade secrets are truly confidential. (The cases where I represent the employer typically fall into this category.) But those cases are rare.

orchestra
Orchestratehr shows the importance of witness preparation in non-compete litigation

There is almost always at least a reasonable argument that the price and customer information the employee received is not really confidential. If you represent the employee, push hard to test whether that is really true, and if it is true, then prepare your client to make that argument and to stick to his guns. It does no good to take the position that the information was not confidential if your client is going to fold under pressure in his deposition and concede that “yeah, I guess that was sort of confidential.” That’s the kind of testimony likely to be cited in a later opinion—like the one in Orchestratehr—holding that the non-compete is enforceable.

Conversely, if you represent the employer who is trying to enforce the non-compete, you need a plan for getting the employee to admit that the information he received was confidential. I would give you some tips on this, but I can’t give away all my secrets.

Legal Issue #2: Do You Really Have to Have a Geographic Limitation?

Like a lot of typical non-competes, the non-compete in Orchestratehr had no express geographic limitation. As the federal district court correctly noted, some Texas appellate courts have held that limiting a non-compete to certain customers can substitute for a geographic limitation. The Orchestratehr court held that, despite the absence of a geographic limitation, limiting the non-compete to existing customers of the company was sufficient.[7]

This is certainly a plausible position, but it is troubling. I am not aware of the Texas Supreme Court ever adopting this position, and the reasonable geographic limitation is an express requirement in the non-compete statute. It would be a little odd for our current Texas Supreme Court, which seems fond of “strict” textual construction of statutes, to interpret the plain language “geographical area” as meaning “geographical area or some reasonable substitute for it.”

Until the Texas Supreme Court definitively resolves the issue, lawyers for Texas employees should continue to argue that, by statute, a Texas non-compete must have an express geographic limitation.

Or “geographical.” If you insist.

____________________________________________

head-shot-photo-of-zach-wolfe

Zach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Austin, Houston, and The Woodlands.

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

[1] See Alex Sheshunoff Mgmt. Servs., L.P. v. Johnson, 209 S.W.3d 644, 655 (Tex. 2006).

[2] Mann Frankfort Stein & Lipp Advisors, Inc. v. Fielding, 289 S.W.3d 844, 850 (Tex. 2009).

[3] Id.

[4] Sheshunoff, 209 S.W.3d at 655 (emphasis added).

[5] The agreement defined Confidential Information as “any information of any kind, nature, or description concerning any matters affecting or relating to Employee’s services for COMPANY, the business or operations of COMPANY, and/or the products, plans, pricing models, customer lists, marketing plans, processes, or other data of COMPANY.”

[6] Orchestratehr, Inc. v. Trombetta, No. 3:13-CV-2110, 2016 WL 4563348, at *3 (N.D. Tex. Sept. 1, 2016).

[7] Id. at *4.

When Is a Non-Compete Not a Non-Compete in Texas?

When Is a Non-Compete Not a Non-Compete in Texas?

Texas Courts are Effectively Ignoring the Legislature’s Command That Restraints of Trade or Commerce Are Illegal

It is a mandatory ritual for judicial candidates in Texas to recite that “a judge’s job is to interpret the law, not make the law.” Thoughtful lawyers who actually handle litigation know this statement is wrong (or at least overly simplistic), but that’s a thorny subject for another day. The point this week is that Texas courts are sidestepping the legislature’s command that restraints of trade or commerce are illegal. The recent federal district court decision Connell v. Wells Fargo illustrates the problem.[1]

Texas has a statute that says every contract in restraint of trade or commerce is unlawful.[2] The statute has an exception that says a “covenant not to compete”—I’ll call it a “non-compete” for short—is enforceable if it meets certain requirements.[3] Thus, enforcement of non-competes is supposed to be the exception, not the rule.

This doesn’t mean non-competes are always bad or always unenforceable. Sometimes I represent the employee; sometimes I represent the employer. As I discussed here, whether a non-compete is enforceable always depends on the circumstances.

campfire-frying-pans
Arguing that a restraint on competition is not a “non-compete” can be jumping out of the frying pan into the fire

Sometimes, when an employer wants to avoid the requirements of the non-compete statute, it will argue that the restraint at issue is enforceable because it is not really a non-compete. But there’s an obvious problem with this argument. If an agreement restrains competition but is not a “non-compete,” it is still a restraint of trade. If it’s a restraint of trade but not a non-compete, then the statute says it is unlawful. So, by trying to avoid the requirements of the non-compete statute, the employer can jump out of the frying pan straight into the fire.

Or at least, that’s the way Texas courts should look at it. The Texas Supreme Court doesn’t always see it this way.

In Exxon Mobil v. Drennen, the Texas Supreme Court addressed a contract that required a former employee to forfeit a significant amount of unvested compensation if he decided to compete with his former employer. The key legal issue was whether the agreement was a non-compete or not.[4]

Let’s pause here. In most areas of the law, courts focus on the actual function of a contractual provision, rather than what the parties label it. In other words, courts typically focus on substance rather than form to decide whether a certain legal principle applies. For example, let’s say the legal principle is that an agreement to pay a real estate commission must be in writing. A real estate agent could not avoid this principle simply by labeling the compensation a “bonus” rather than a “commission.” That would be silly.

So, you would think that a court would determine whether a contract is a “non-compete” by asking whether the contract serves the function of restraining or discouraging the employee from competing with the employer. In other words, you would think a court would put substance over form. But you would be wrong.

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Exxon Mobil v. Drennen elevated form over substance

In Drennen, the Texas Supreme Court put form over substance by holding that a forfeiture clause triggered by an employee competing with the employer is not a non-compete. For the reasons explained above, I think this was wrong. Again, I’m not necessarily saying the agreement was unfair or unenforceable, just that this kind of forfeiture clause obviously functions as a non-compete and should be evaluated as such.

But then the Texas Supreme Court compounded the error with a second mistake. It declined to consider whether the forfeiture clause was an unlawful restraint on trade or commerce.

As explained above, if an agreement restrains trade or commerce but is not a “non-compete,” then it falls under the general rule for restraints of trade, rather than the exception for non-competes. It would then be unlawful and contrary to Texas public policy. But the Drennen court punted on this issue, refusing to decide whether a forfeiture clause that restrains competition is an unlawful restraint of trade.[5]

This was also a mistake. Drennen should have decided the issue rather than punting, and the effect of Drennen’s error is apparent in the recent Connell v. Wells Fargo case. The plaintiffs in Connell argued that a forfeiture clause in their contracts violated a fundamental Texas policy because either (a) it was an unenforceable non-compete, or (b) it was an unenforceable restraint of trade. The federal district court disagreed. Under Drennen, the court said, a forfeiture of unvested compensation is not a non-compete.

But was the forfeiture clause an unlawful restraint of trade? The Connell court rejected this argument also, reasoning that (a) the Texas Supreme Court declined to decide this issue in Drennen, and (b) Drennen held that Texas has no “fundamental policy” against such clauses, even if Texas courts might eventually find that they are unlawful.

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Connell v. Wells Fargo followed Drennen

So let me get this straight. A forfeiture clause that restrains competition but is not a “non-compete” might be unlawful under Texas law, but even if it is unlawful, it doesn’t implicate any fundamental Texas policy?

It’s hard to fault the district court in Connell for applying Texas law as expressed pretty clearly in Drennen, but something is wrong here. If Texas courts are going to allow employers to avoid application of the non-compete statute by arguing that a non-compete is not really a non-compete, then Texas courts should at least consider whether the agreement is instead a restraint of trade prohibited by the legislature.

Because the legislature makes the law, right?

_______________________________________________________________

head-shot-photo-of-zach-wolfe

Zach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Austin, Houston, and The Woodlands.

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

[1] Connell v. Wells Fargo & Co., 2016 WL 4733448 (S.D. Tex. Sept. 12, 2016).

[2] Tex. Bus. & Com. Code § 15.05(a).

[3] Tex. Bus. & Com. Code § 15.50.

[4] Exxon Mobil Corp. v. Drennen, 452 S.W.3d 319 (Tex. 2014).

[5] Drennen was able to avoid the issue because the question was whether the clause violated a “fundamental policy” of Texas for choice-of-law purposes. The contract in Drennen selected New York law, which allows the kind of forfeiture clause at issue. I previously wrote about Texas choice of law principles for non-competes in This Stuff’s Made in New York City!