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

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

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

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

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

“Wolfe here.”

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

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

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

“Ok, cool. Send it over.”*

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

Ok, Fivers, here’s the question:

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

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

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

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

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

The correct ruling on the motion is:

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

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

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

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

So what’s the best answer? No peeking.

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

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

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

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

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

Tex. Bus. & Com. Code § 15.51(c).

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

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

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

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

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

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

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

So why is the availability of reformation an unanswered question?

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

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

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

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

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

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

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Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. He doesn’t really have that ring tone, but it would be cooler if he did.

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.

*It should be obvious that all the stuff above about the Texas bar exam is made up. Then again, the news about the California bar exam sounded fake too.

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

To start, here is perhaps the most basic unanswered question: to enforce a non-compete against a departing employee, does the employer have to prove that the information it provided to the employee was actually confidential?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Id. at 655-56.

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

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

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

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

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

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

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

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

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

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

The district court cited DeSantis v. Wackenhut Corp., 793 S.W.2d 670 (Tex. 1990), where “the Texas Supreme Court rejected the plaintiff’s claim that its supposed confidential information—the identity of their customers, pricing policies, cost factors, and bidding strategies—was protectable under the confidentiality agreement.” The court in Wackenhut explained that the plaintiff “failed to show that its customers could not readily be identified by someone outside its employ, that such knowledge carried some competitive advantage, or that its customers’ needs could not be ascertained simply by inquiry addressed to those customers themselves.”

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

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

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

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

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

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

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

 

The short answer is yes. A non-solicitation agreement is a form of non-compete.

But why does this issue come up? And what difference does it make?

To understand why, let’s back up a bit. It is common for an employment agreement to contain both a “non-solicitation” section and a “non-compete” section. A non-solicitation clause places restrictions on the employee soliciting company customers after leaving the company. A non-compete clause is broader: it places restrictions on the employee working for a competitor after leaving the company.

Every state limits the enforceability of non-competes in some way. In Texas, where I practice, we have a statute declaring that every contract in restraint of trade or commerce is unlawful.[1] But the statute has a large exception for a “covenant not to compete.”

So what about a covenant not to “solicit”? How does that fit into the statutory scheme?

There are really only two options. A contractual covenant not to solicit is either a “restraint of trade or commerce,” which is illegal, or a form of “covenant not to compete,” which is enforceable if it meets the requirements of the non-compete statute.

It’s pretty easy to see why a non-solicitation agreement is a restraint of trade or commerce. Think about it. Imagine if Apple and Samsung signed a contract saying that Apple will not solicit smartphone customers in Asia, and Samsung will not solicit smartphone customers in North America. The Justice Department would be all over that.

It should be no different if the non-solicitation agreement is part of an employment contract.[2]

You can see where this is headed. It shouldn’t help the company to argue that the non-solicitation agreement is not a “non-compete.” If that’s true, it’s an illegal restraint of trade. I’ve made this point before. See When is a Non-Compete Not a Non-Compete in Texas?

But even aside from this dilemma for the employer, there are two reasons why a non-solicitation agreement should be treated as a “non-compete” that is subject to the restrictions in the non-compete statute.

First, common sense. Let’s say I draft a contract that says the employee shall not “cheat” for a period of one year after leaving the employer, with “cheat” defined as “to work for a company that provides similar goods or services as those provided by Employer.”

Hey, it doesn’t use the word “compete,” so it’s not a “covenant not to compete” subject to the statute, is it?

Of course it is. The law isn’t going to let a company get around the requirements of the non-compete statute merely by using some label other than “compete.” The question is whether the function of the clause is to restrict competition. An agreement not to solicit the employer’s customers obviously restricts competition with the employer and therefore should be treated as a “covenant not to compete.”

The second reason that a non-solicitation agreement is a “covenant not to compete” is that the Texas Supreme Court has said so. This is more important than the first reason.

In Marsh USA Inc. v. Cook, 354 S.W.3d 764, 768 (Tex. 2011), the Texas Supreme Court clarified Texas law on enforceability of non-competes. The agreement in Marsh prohibited the employee from soliciting a certain type of business from people who were clients or prospective clients of his employer within two years of his termination.

Under the heading “Enforceability of the Covenant Not to Compete,” the Texas Supreme Court began its analysis by stating:

Covenants that place limits on former employees’ professional mobility or restrict their  solicitation of the former employers’ customers and employees are restraints of trade and are governed by the Act [meaning the Texas Covenants Not to Compete Act].

In support, the court cited two state court cases and two federal court cases treating non-solicitation agreements as non-competes.

So that should settle it. A non-solicitation covenant is a kind of “covenant not to compete.”

But what difference does it make?

It matters because a covenant not to compete must meet the two requirements of the statute. First, it must be “ancillary to an otherwise enforceable agreement.” Second, it must be reasonable in time, scope, and geographic area. You can watch a brilliant five-minute video on these requirements here.

The geographic area requirement is often a sticking point. Despite the unambiguous requirement in the statute, it is not unusual to find a non-solicitation clause, or even a broader non-competition clause, that contains no geographic limitation. When that happens, the employee can argue that absence of a geographic limitation renders the clause unenforceable as written.

That’s exactly one of the arguments the employee made in the recent case White v. Impact Floors of Texas, LP, No. 05-18-00384-CV, 2018 WL 6616973, at *3 (Tex. App.—Dallas Dec. 18, 2018, no pet. h.).

In Impact Floors, the trial court granted a temporary injunction enforcing the non-solicitation and non-disclosure provisions of an employment agreement. Id. at *1-2. On appeal, the employee argued the trial court was wrong to enter the injunction because the employment agreement contained no geographic limitation. Id. at *3.

That should have been a pretty easy issue for the Court of Appeals, right? As we’ve seen the Texas non-compete statute applies to a non-solicitation agreement, and the statute expressly requires a reasonable geographic limitation.

But the Court of Appeals rejected the employee’s argument on the ground that the injunction only enforced the non-solicitation and non-disclosure provisions of the agreement, not the non-compete provision. Id. at *3.

I’ll leave it to the appellate specialists to argue whether the Court of Appeals got this right on narrow procedural grounds.[3] But as discussed above, the Texas Supreme Court has specifically said the requirements of the non-compete statute apply to a non-solicitation agreement. So, to the extent that Impact Floors says otherwise, it is wrong.

But there is another way to get to the same result. Despite the plain language of the statute requiring reasonable limitations as to “geographical area,” some Texas courts have said that a limitation on the scope of a non-compete—such as limiting it to the employee’s clients—can be used in lieu of a geographic limitation.[4]

So if you’re the lawyer representing the employee, don’t get too excited if the non-solicitation clause has no geographic limitation. It might still be enforceable as written. And even if it’s unenforceable as written, the trial court judge could still grant a temporary injunction enforcing it to a more limited extent.

But don’t let the employer’s lawyer get away with arguing that a non-solicitation clause isn’t a non-compete. That’s just incorrect.

In my opinion.*

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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.

[1] Tex. Bus. & Com. Code § 15.05.

[2] See, e.g., Rimkus Consulting Group, Inc. v. Cammarata, 255 F.R.D. 417, 438-39 (S.D. Tex. 2008) (stating that a “nonsolicitation covenant is also a restraint on trade and competition and must meet the criteria of section 15.50 of the Texas Business and Commerce Code to be enforceable”).

[3] The Court of Appeals reasoned that the employee complained on appeal only about the non-compete provision, but that the temporary injunction did not enforce the non-compete provision, so therefore the employee’s complaint presented nothing for appellate review. Id.

[4] See Gallagher Healthcare Ins. Servs. v. Vogelsang, 312 S.W.3d 640, 654-55 (Tex. App.—Houston [1st Dist.] 2009, pet. denied) (“A number of courts have held that a non-compete covenant that is limited to the employee’s clients is a reasonable alternative to a geographical limit”); M-I LLC v. Stelly, 733 F.Supp.2d 759, 799-800 (S.D. Tex. 2010) (taking “holistic” approach and holding that absence of geographic restriction did not render non-compete unenforceable where time period was only six months, employee held upper management position, and employee had access to company’s trade secrets).

Fivers, did you know I have a YouTube channel? It’s called That Non-Compete Lawyer. I named it that because I’m a lawyer, and . . . ok, you get it.

I thought about naming it That Houston Lawyer Who Does a Lot of Different Kinds of Business Litigation but in Recent Years Mainly Litigation Involving Departing Employee Issues Like Non-Competes and Trade Secrets*. But that just didn’t have the same ring to it.

Anyway, I’ve had this YouTube channel for a while. It’s the home for my series of videos explaining non-compete issues in a way that lawyers and other humans can both easily understand.

It’s also the hub for my series of “Top 5 Tuesday” videos. I consider them both insightful and hilarious, providing useful legal information in an entertaining way, while critics have expressed amazement at how they manage to be dull and frivolous at the same time.

But now I’ve launched something even more amazing: Essentials of Texas Non-Compete Litigation. It’s a 30-minute video course in 15 installments. As you math majors will deduce, that’s an average of two minutes per installment.

And I would venture to say there has never been a better 30-minute YouTube course on Texas non-compete litigation. I mean, it’s no Dude Perfect, but I think you’ll like it. And when you watch, be sure to follow along with my free Study Guide. It has helpful case cites and tips on additional reading. (Spoiler: there’s a heavy dose of Five Minute Law posts in the “Additional Reading.”)

Love it? Hate it? Is there something essential I left out? Did I get anything wrong? Was there anything I could have cut? If so, I’m pretty sure there is a way to communicate that to me through YouTube’s popular platform. Or if you’re not that tech-savvy, you can just text me on your flip phone.

FAQ

Is Essentials of Non-Compete Litigation approved for CLE credit in Texas? No, but I’ll look into that.

Is it better to watch one episode at a time, or to binge-watch the whole series in one weekend? I leave this to your discretion.

Can one Texas trial lawyer cover the essentials of Texas non-compete litigation in just 30 minutes? There’s only one way to find out.

Is there a GoFundMe campaign to get you better lighting and sound? Not yet, but I like the way you think.

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Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. He hopes to continue litigating even after becoming a viral YouTube sensation. 

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.

*Not certified by the Texas Board of Legal Specialization

It’s my anniversary. Two years ago today I launched this blog with What a Litigator Looks For in the Typical Texas Non-Compete. I thought it best to start with a topic I know. I outlined the five things I look for to determine if a non-compete is enforceable under Texas law.

That post has held up pretty well. Since then, I’ve seen plenty more non-competes. Texas non-compete law hasn’t fundamentally changed, and I still look for those five things. So, if you want an intro to Texas non-compete law, that post is still a good place to start. Or you can watch a video version here.

But two more years have taught me there is a simpler question to ask when a client brings me a non-compete. As a general rule, you can boil down the practical effect of Texas non-compete law to just seven words: you can’t take your customers with you.

What do I mean? If you’re a sales person who has a non-compete and relationships with customers—the most common situation—it is likely a judge will order you not to do business with your customers from your previous company. But the judge shouldn’t completely bar you from working for a competitor.

In other words, you can compete for new customers, but you can’t take your old customers with you. I call this Wolfe’s First Law of Texas Non-Compete Litigation.*

It’s really more of a general rule, but I like the sound of “First Law” more than “First General Rule.”

It’s just a rule of thumb because like most legal rules, it has exceptions, and the whole truth is more complicated. Still, experience has taught me that nine times out of ten, my First Law will hold true.

This means if you’re an employer trying to stop an employee from violating a non-compete, you can probably prevent the employee from taking her customers with her, but you probably can’t do more than that.

If that’s all you need to know, you can stop here. If you want to understand why, read on.

The reasoning behind Wolfe’s First Law of Texas Non-Compete Litigation

Here’s how I get there. The Texas non-compete statute has two requirements: (1) a non-compete must be “ancillary to an otherwise enforceable agreement,” and (2) it must be reasonable.

Employers usually meet the first requirement by (a) expressly stating in the non-compete that they will give the employee confidential information, and (b) actually giving the employee confidential information. A Texas Supreme Court case called Sheshunoff clarified that this will do the trick.

This is where the first big exception comes in. You will sometimes run across a non-compete that does not expressly promise to give the employee confidential information. Usually when you see that it’s either a really old non-compete, or a non-compete drafted for a multi-state company without Texas in mind.

If there is no express promise, you have to look at whether there was an implied promise to provide confidential information. A case called Mann Frankfort said the promise is implied if the nature of the employee’s work necessarily involves providing confidential information. That can be a fact-intensive issue.

Most employers avoid this detour by including an express promise to provide confidential information in the non-compete. Then the second big exception comes into play: did the employer actually provide confidential information to the employee?

I have had cases where there was a genuine dispute about whether the information was really confidential. You are more likely to see this in situations where an employee already had a book of business when he joined the company, or where sales people are entirely responsible for generating their own leads and customers. If the employer didn’t provide confidential information, the non-compete is unenforceable.

But most of the time, it’s pretty easy for the company to show that it provided some confidential information to the employee.

Now that we’ve cleared those possible exceptions out of the way, it’s time to turn to reasonableness.

Let’s be reasonable

Like most states, Texas requires a non-compete to be reasonable in time period, geographic area, and scope of activity restrained.

The good news for employees is that there is almost always at least a decent argument that some aspect of the non-compete is unreasonably broad. Especially the “scope of activity” part. While most Texas lawyers are pretty good about including a reasonable time period and geographic limitation, Texas non-competes are often too broad in the scope of activity they restrict.

Maybe this is because the scope of activity limitation is largely defined by the case law, so a lawyer who only reads the statute won’t get the whole picture. The case law says that an “industry-wide exclusion”—a restriction that prevents the employee for working in the same industry in any way—is too broad.

That’s because a non-compete should be limited to protecting the employer’s goodwill, i.e. its relationships with existing customers. The simplest way to do this is to say–usually in one really long sentence with fancier words–that the employee can’t take her customers with her. That’s a reasonable scope (generally). On the other hand, a non-compete that bars the employee from working for a competitor in any way is usually too broad and therefore unenforceable as written.

But employees shouldn’t get too excited. There is also good news for the employer.

First, note I said unenforceable “as written.” The non-compete statute says that if the non-compete is too broad, the judge must reform it—i.e., rewrite it—to the extent necessary to make it reasonable.

Second, even if the non-compete is too broad, as a practical matter a judge can still issue a temporary injunction to enforce the non-compete to a reasonable extent.[1] (A temporary injunction is an order that applies while the lawsuit is pending.)

Now you can see Wolfe’s First Law coming into focus. When you put all this together, you get two likely scenarios. If the non-compete is reasonable in scope because it is limited to preventing the employee from taking her customers with her, then the judge is likely to grant a temporary injunction that enforces the non-compete as written. If the non-compete is unreasonable in scope because it is not so limited, the judge is likely to limit the injunction to a reasonable scope, i.e. preventing the employee from taking her customers with her.

In either case, the effect is the same. And Wolfe’s First Law of Texas Non-Compete Litigation holds true.

Caveat Five-or

Again, there are exceptions. For example, some judges take the “irreparable injury” rule seriously. That rule says that a court should not grant an injunction if damages would be adequate to compensate the company for the employee’s violation of the non-compete.

My personal view—perhaps a post for another day—is that courts should apply this requirement more strictly. In most cases damages would be adequate to compensate the employer for any lost customers.

But most judges are not so fastidious about the irreparable injury rule. If the judge thinks the employee is violating the non-compete by steering competitors to the employee’s new company, a temporary injunction is likely.

Of course, a temporary injunction is not the end of the story. It is temporary, after all.

Still, in most cases a temporary injunction enforcing the non-compete might as well be a permanent injunction. Why? Remember that a non-compete must be reasonably limited in time. Time periods of three years or longer have sometimes been held reasonable, but most non-competes are limited to one or two years.

How long do you think it usually takes for a case to get to trial? (Hint: at least one or two years.) That means that in many cases, the non-compete will expire before the case goes to trial, or around that time. That’s why I say a temporary injunction might as well be a permanent injunction.

So maybe we should modify Wolfe’s First Law to say this: you can’t take your customers with you, until a year or two after you leave.

But that just doesn’t have the same ring to it.

*Update: There is an important exception: cases where I represent the defendants. But seriously, what if the employee isn’t “taking” the customers, but the customers want to follow the employee without any solicitation by the employee? That’s a different question.

___________________________________________________________________

Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Someday he will come up with a “Wolfe’s Second Law” for something.

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] Reformation is a remedy that typically would not be granted until a final judgment after trial. There is some legal question about whether the judge at a temporary injunction hearing should (1) reform the non-compete as a temporary remedy and enter a temporary injunction enforcing the reformed non-compete, or (2) simply enter a temporary injunction that only partially enforces the non-compete to a reasonable extent. The distinction seems largely academic.

Is the reasonableness of a Texas non-compete a question of law or a question of fact?

I was once defending a Texas non-compete lawsuit and taking the deposition of the business owner who was trying to enforce the non-compete. I asked if he had any view of what a reasonable length of time for the non-compete would be. His answer: “when hell freezes over.”

That’s why I love litigation.

Recalling that answer got me thinking about an important issue in non-compete law: Is the reasonableness of a non-compete a question of law or a question of fact? If you’ve read a few Texas non-compete cases, you may already know the answer. There are dozens of cases reciting that the reasonableness of a non-compete is a question of law.

And all of those cases are wrong.

Or at least they are only partially correct. Why?

Before we can answer that question, we need to tackle a deeper jurisprudential question, the kind that law professors love: what is the difference between a question of law and a question of fact?

Deep thoughts on questions of law and fact

Let’s start with the easy part. A pure question of law is a legal issue that can be stated entirely in the abstract, without any reference to the particular facts of a case. Let’s say you’re in a car crash and the question is “what is the statute of limitations for a negligence claim?” That’s a pure question of law.

That doesn’t necessarily mean the question has a simple answer. It just means you can answer the question without knowing anything about any facts. For example, the general rule in Texas would be that you have to file a negligence lawsuit within two years of the car accident.

A pure question of fact, on the other hand, has nothing to do with law. “Did the defendant run a red light?” is a pure question of fact. (There are also “mixed” questions of law and fact, the classic example being the standard of care in a negligence or malpractice case, but let’s put that aside for the moment.)

It gets more complicated when the question applies an abstract legal principle to a particular scenario. Let’s take the question “does the statute of limitations start running at the time of the accident, or when the plaintiff discovered the extent of his injuries?” That sounds more factual, but it’s still a question of law, because it simply applies an abstract principle to a given factual situation.

Now let’s make it harder. My lawyer readers will know the “discovery rule.” The discovery rule is an exception that keeps the limitations clock from starting until the plaintiff discovered, or reasonably should have discovered, the injury. Is applying the discovery rule in a particular case a question of law or a question of fact?

This is where judges tend to go wrong. Perhaps nothing provides a better opportunity for superficial judicial analysis than whether an issue is a question of law or fact.

For example, if the judge thinks it’s a question of fact, she will typically write “the discovery rule is a question of fact for the jury,” cite some cases that said it was a question of fact, and be done with it. Similarly, if the judge thinks it’s a question of law, the judge will write “the discovery rule is a question of law,” cite some cases that said that, and move on.

This is superficial, and wrong. If judges would only remember what their law school professors said, they would say the answer is “it depends.”

It depends. Of course, it depends! It depends on what the evidence is. For example, if the undisputed evidence shows that the plaintiff discovered his injury more than two years before filing suit, then it’s a question of law. You’re just applying a legal principle to an undisputed set of facts. But if there is conflicting evidence about when the plaintiff discovered his injury (or should have discovered it), it’s a question of fact.

Pretty simple, right? But trust me, courts mess this up all the time. Sometimes it may just be intellectual laziness. But often it’s more than that.

Does it matter whether it’s a question of law or fact?

You may be wondering why it matters. What difference does it make whether we call an issue a question of law or a question of fact? Isn’t this just philosophical musing?

No. It matters whether an issue is a question of law or fact because that determines who gets to decide the issue. If it’s a question of law, the judge decides. But if it’s a question of fact, that means the factfinder gets to answer the question. Depending on the type of proceeding, the factfinder could be the judge, the jury, or an arbitrator.

Now, I know a lot of my Fivers are stone-cold realists. You may question whether there is any principled distinction between a question of law and a question of fact. You might say that asking “is it a question of law or fact?” is nothing more than asking “does the judge or the jury get to decide the question?”

That would be going too far. The distinction between a question of law and a question of fact is real, even if it is sometimes difficult to draw that line. But it is important to understand that the practical effect of the answer is to determine whether the judge or the jury gets to decide.

Whether the issue is a question of law or question of fact also determines who gets to decide the issue on appeal. Generally, the appellate court will defer to the factfinder on questions of fact but will decide questions of law de novo. “De novo” is a Latin phrase that means “I don’t care what a lowly trial court judge thinks.”[1]

Is the picture coming into focus now? If I’m the judge and I have a certain view of what a fair outcome would be, might that have some effect on whether I characterize an issue as a question of law or question of fact?

Let’s take our statute of limitations example. If I think the case should go to trial, I might be inclined to simply proclaim that the discovery rule is a question of fact for the jury and leave it at that. Conversely, if I think the case has no merit, I might be inclined to say it’s a question of law and grant summary judgment for the defendant.

I’m not necessarily suggesting there is anything sinister about this. Even the most impartial judges will tend to characterize the issue in a way that favors an outcome they sincerely believe is fair and just. That’s true even before you add external forces to the mix—say, campaign contributions from “tort reform” groups or plaintiff’s lawyers.

But there is a better way: it depends. It depends on the evidence. If the relevant evidence is undisputed, it’s a question of law. If the relevant evidence is conflicting, it’s a question of fact.

This proposition, though often ignored, shouldn’t be controversial. If you think it’s wrong, please tell me why.

Let’s apply what we’ve learned 

Now let’s apply this not-so-controversial principle to a typical Texas non-compete.

Texas, like most states, requires a non-compete to be reasonable in time period, geographic area, and scope of activity restrained. So, is the reasonableness of a Texas non-compete a question of law or a question of fact?

You already know where this is headed, but let’s break it down.

What do we mean by “reasonable,” as applied to a non-compete? Fortunately, the Texas non-compete statute gives us a clue. It says the non-compete must have “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.”[2] For the typical Texas non-compete, which is tied to a confidentiality agreement, reasonableness comes down to whether the limitations are no greater than necessary to protect the company’s goodwill and confidential information.

So how about a three-year time period? Is that reasonably necessary to protect the employer’s goodwill and confidential information? And what about a geographic area of the State of Texas? Is that reasonable?

You’re probably having trouble answering these questions in the abstract. That’s because you don’t know anything about the facts of the case. It would make a difference whether it takes three months or three years for the confidential information to become outdated and useless. It matters whether the company sells products to customers throughout the State of Texas or in just one city.

If you don’t know the answers to these questions, there is no way you can know if the time period and geographic area are reasonable. You simply cannot determine the reasonableness of the non-compete in the abstract.

And yet, many Texas cases recite that the reasonableness of the non-compete is a question of law. As I said earlier, that is either wrong or only partially correct. Reasonableness could only be a question of law if the facts concerning reasonableness are not in dispute. If there is conflicting evidence material to reasonableness, it’s a question of fact.

And I can prove it. My witness is the Texas legislature, and my Exhibit 1 is Section 15.51 of the Texas Business and Commerce Code. It says:

If the primary purpose of the agreement to which the covenant is ancillary is to obligate the promisor to render personal services, for a term or at will, the promisee has the burden of establishing that the covenant meets the criteria specified by Section 15.50 of this code. . . . For the purposes of this subsection, the “burden of establishing” a fact means the burden of persuading the triers of fact that the existence of the fact is more probable than its nonexistence

“Triers of fact”? Who could that possibly be referring to if it’s a question of law?

Let me translate. This means that for a non-compete in a typical employment agreement, the employer has the burden of proving the non-compete is reasonable.

This proves my point that the reasonableness of a non-compete can be a question of fact, provided there is conflicting evidence. How else could there be a burden of proof on the issue? Questions of law don’t have a burden of proof.

Why this matters in non-compete litigation

This explains why I was asking that deposition question about a reasonable time period for the non-compete. I knew it was the employer’s burden to prove that the time period in the contract was reasonable. I wanted to nail down whether the employer had any evidence to offer that the time period was reasonable. He didn’t.

Wait a minute, you say. Even if you’re technically correct, isn’t this just a case of sloppy language? Opinions that say it’s a question of law may still be getting the result right, if the undisputed facts of the case establish that the non-compete was either reasonable or unreasonable.

True. But the issue is not academic. For one thing, treating reasonableness of a non-compete as a question of law tends to favor enforcement of the non-compete. In theory, the judge could just as easily find a non-compete unenforceable as a matter of law. But in practice, the vast majority of cases that say reasonableness is a question of law also say the non-compete was reasonable, and therefore enforceable. So, the outcome of this philosophical issue can make a real practical difference.

Now that I’ve cleared this up, when can we expect Texas appellate courts to stop proclaiming without qualification that the reasonableness of a non-compete is a question of law for the court?

I’d say probably when hell freezes over.

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

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

[1] Appellate lawyers call this the “standard of review.” Standard of review is one of those issues that is really, really exciting for appellate lawyers and boring for just about everyone else.

[2] Tex. Bus. & Com. Code § 15.50(a).

Do you have a college degree in restaurant and hotel management? Have I got a deal for you.

Work as an assistant manager at Buc-ee’s, the well-known Texas highway stop with the clean restrooms, massive selection of snacks, and funny billboards. On top of a weekly salary of $862.75, you will get a monthly bonus, I mean, “retention payment,” of 1.2652% of the store’s monthly net profit.

Naturally, your employment will be at-will, meaning Buc-ee’s can fire you at any time for any reason, or for no reason. That’s ok, because you can also quit for any reason, or for no reason.

But here’s the catch. If you quit or get fired in less than four years, or if you don’t give Buc-ee’s written notice at least 6 months before quitting, you have to pay back all of the retention payments you received, plus interest and attorneys’ fees.

In other words, you can check out any time you like, but you can never leave.

That was the basic deal in Rieves v. Buc-ee’s, a case decided by the Houston Court of Appeals (14th District).[1] Rieves, the employee, received about $67,000 in retention payments, paying federal income taxes on them, but quit the job three years in. Buc-ee’s sued her to recover the $67,000 plus interest and attorneys’ fees.

That doesn’t sound fair, you may be thinking, but this is Texas, and a deal’s a deal, right?

Well, yes, “that’s not fair” is usually not a defense to enforcement of a contract, and “unfairness” is not an exception to the at-will employment doctrine.

But it’s not just a question of enforcing the parties’ contract. The public’s interest in free competition is also at stake. That’s why Texas has a statute that says every contract in restraint of trade or commerce is illegal. The statute has an exception for non-competes, but the non-compete has to be reasonable in scope.

So, Rieves argued that the contract’s requirement to pay back the retention payments was an unenforceable restraint of trade, and the Houston Court of Appeals agreed.

Limitations on employee mobility must meet the reasonableness requirement for non-competes

Under Texas case law, the court said, limitations on employee mobility are unenforceable unless they fall within the statutory exception for non-competes. This rule applies not only to provisions that expressly limit employee mobility, but also to damages clauses that impose a “severe economic penalty” on a departing employee. Because the contract imposed a severe economic penalty on Rieves for exercising her right to quit, the court reasoned that the contract was unlawful unless it met the reasonableness requirements for non-competes.

The problem for Buc-ee’s? The contract had no limits on the employee’s repayment obligation based on whether her new employment involved competitive activities or was located within certain areas. Not only that, the contract gave Buc-ee’s the right to enforce the repayment provision even if, for example, Buc-ee’s fired the employee without cause on the last day of the four-year period, or if the employee quit to take a noncompeting job, or no job at all.

This was just too much, even for the relatively conservative 14th Court of Appeals.

“These provisions go far beyond protecting any legitimate competitive interest of Buc-ee’s,” Justice Busby wrote for the court, “impose significant hardship on Rieves by clawing back substantial compensation already paid to her and on which she had paid taxes, and injure the public by limiting choice and mobility of skilled employees.” The court therefore rendered judgment that the repayment provision of the contract was unenforceable.

That sounds like a fairly common-sense application of Texas law, right?

What about ExxonMobil v. Drennen?

But those of you who follow Texas non-compete law may be thinking, what about Drennen?

Exxon Mobil v. Drennen was a Texas Supreme Court case decided in 2014.[2] Technically, it addressed a narrow issue only a lawyer could love: choice of law. The contract at issue in Drennen required an executive to forfeit stock options if he went to work for a competitor. New York law allows that sort of thing, and the legal issue presented was whether the Texas court should apply New York law or Texas law.

I won’t get down in the weeds of the choice of law analysis, but the key was that one step was to ask whether Texas has any “fundamental policy” against this kind of forfeiture provision.

Some of you may recall a certain statute that says something about, what was it, restraints of trade or commerce being unlawful? That kind of sounds like a “fundamental policy” to me.

But the Texas Supreme Court didn’t see it that way. It held in Drennen that there was no fundamental Texas policy that would bar the forfeiture clause, and that cleared the way for New York law to apply.

As explained here, I thought Drennen got it wrong on this point. In my view, Texas courts should take the legislature’s ban on restraints of trade more seriously. But of course I don’t get to make the rules. And while bloggers and pundits are free to criticize, the Texas Courts of Appeals have to follow what the Texas Supreme Court says.

So if Drennen said the forfeiture of employee benefits does not violate Texas public policy, why didn’t that control the outcome in the Buc-ee’s case?

The Buc-ee’s court found that Drennen did not apply. First, the type of compensation at issue was different. In Drennen, it was forfeiture of future unvested stock options, while in Buc-ee’s it was money already paid to the employee, on which she had already paid income taxes.

Second, the Buc-ee’s contract was different because, unlike the stock option provision in Drennen, it did not necessarily reward the employee for her loyalty. The contract required the employee to pay back a substantial part of her compensation even if Buc-ee’s fired her, and the longer she worked at Buc-ee’s, the larger the penalty if she decided to quit.

The Bigger Picture

The Buc-ee’s decision shows that some Texas courts still take the legislature seriously when it says that restraints of trade are unlawful. It’s an important decision, because it restores some balance to the basic social contract that Texas law provides to businesses and employees.

The at-will employment doctrine and the ban on restraints of trade are two sides of this coin. What’s in it for business is they can hire and fire at will, with only some narrow exceptions (like unlawful discrimination).

The at-will employment doctrine is widely known but not fully appreciated. Everybody knows that employers can fire employees at will, yet with most people that knowledge really hasn’t sunk in. In the back of their minds, employees still seem to feel that employers can’t fire them for a bad reason.

But they can, and that’s a big deal. I would even say the at-will employment doctrine is the most serious source of injustice in the workplace in America.[3]

Think about it. At-will employment means you can slave away for the same company for twenty years and get fired because the owner wanted to make room for his son who just got out of college and needs a job. It’s just not fair!

Yet I fully support the at-will employment doctrine. While at-will employment is a source of great injustice on the “micro” level, we accept it as a necessity for its “macro” benefits, which fall into two categories.

First, there is the judicial capability problem. While judges sometimes speak of at-will employment as if it were some immutable law of nature, it isn’t. Courts could adopt a common-law rule that employers must have good cause to fire an employee. But imagine all the lawsuits that would follow. And imagine all the inconsistent and subjective rulings by judges and juries on “good cause.”

Second, we accept at-will employment for its economic benefits. The ability to hire and fire freely boosts overall economic growth and employment, benefitting everyone. If employers could only fire for good cause, think of how reluctant they would be to hire in the first place. At-will employment also encourages employee mobility, which increases competition.

But this gets to the other side of the deal: at-will employment has to be a two-way street. Just as employers can fire for any reason, or for no reason, employees have to be free to say “take this job and shove it.” Not only that, employees must be able to leave and work for a competitor (unless there is a reasonably limited non-compete). That’s the balance that makes at-will employment work.

The basic problem in Buc-ee’s was that the employer tried to upset this balance. Buc-ee’s wanted to have its beef jerky and eat it too: we can fire you any time for any reason, but we’re also going to make it cost-prohibitive for you to decide to leave.

This was just too much for the Houston Court of Appeals. You can’t always get what you want.

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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. As a litigator he drives around Texas a lot and loves stopping at Buc-ee’s.

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] Rieves v. Buc-ee’s Ltd., 532 S.W.3d 845 (Tex. App.—Houston [14th Dist.] 2017, no pet.).

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

[3] This is not to downplay harassment and discrimination, which are certainly real problems.