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

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

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

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

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

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

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

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

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

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

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

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

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

Why is that?

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

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

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

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

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

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

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

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

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

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

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

Let’s look at a recent example.

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

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

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

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

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

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

But what if the defendants had offered evidence?

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

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

_______________________

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

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

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

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

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

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

This leads us to General Rule No. 5.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Id. at 798-99.

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

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

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

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

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

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

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

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

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

Maybe it’s time to hit rewind.

_____________________________________

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.

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

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

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

The traditional connection between physical proximity and customer goodwill

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

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

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

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

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

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

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

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

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

The Sales Territory principle

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

I feel like I should save that for Part 2.

Do you feel like I do?

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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.

Sometimes a Texas non-compete will take the form of forfeiture clause rather than an express prohibition on competing. For example, let’s say a company awards equity ownership to a valued employee, with a clause stating that the employee will forfeit that ownership if he competes. Is that a non-compete? And does it matter whether a court classifies it as a non-compete or something else?

*Disclaimer: This is an issue in a case I’m currently litigating. I said it once before, but it bears repeating: everything in this post is just my personal opinion, not the opinion of my firm or clients. Although in this case, my personal opinion aligns with my client’s position pretty well, so it’s not a big deal.

In my opinion, the answers should be yes, the agreement is a non-compete and no, it does not ultimately matter because either way, the scope of the clause must be reasonable.

But the issue is open to debate, and there are several plausible answers under current Texas case law:

A. The forfeiture clause functions as a non-compete and therefore must meet the requirements of the non-compete statute.

B. The forfeiture clause is not a non-compete because it doesn’t actually prohibit the employee from competing; it just says the employee will forfeit some benefit if he competes.

C. Whether the forfeiture clause is a non-compete depends on the nature of the incentive plan; if it is a non-contributory profit-sharing plan, it probably isn’t a non-compete, but if the employee owns vested shares in the company, it probably is a non-compete.

D. Regardless of whether the forfeiture clause is a non-compete, it must be reasonable to be enforceable.

The bottom line is that the answer is unclear.

So for Texas lawyers who draft non-competes for employers, there are two things to remember. First, putting the non-compete in the form of a forfeiture clause won’t necessarily avoid the requirements of the non-compete statute. Second, regardless of what you call it, a Texas court probably will not enforce a forfeiture clause that functions as an unreasonably broad non-compete. So you might as well make the scope of the discouraged competition reasonable.

If that’s all you need to know, you can skip the rest. If you want to understand why, keep it tuned right here.

Conflicting Cases?

The trouble is that we have two Texas Supreme Court opinions that cut in different directions on this issue.

In Peat Marwick Main & Co. v. Haass, 818 S.W.2d 381, 385 (Tex. 1991), the court held that an agreement that does not expressly prohibit competition but imposes a financial penalty for competition is subject to the requirements of the non-compete statute.

But in Exxon Mobil Corp. v. Drennen, 452 S.W.3d 319, 329 (Tex. 2014), the court said that a forfeiture clause in an employee’s non-contributory profit-sharing plan is not a “covenant not to compete,” reasoning that it does not restrict the employee’s future employment but only makes the employee choose between keeping the profit-sharing and working for a competitor.

There are several plausible ways to interpret these apparently contradictory holdings:

1. Drennen implicitly overruled Haass, establishing a broad rule that places form over substance by simply asking whether the agreement expressly prohibits competition.
2. Drennen established a narrow exception to Haass for forfeiture of unvested shares that had been awarded but not yet delivered pursuant to a non-contributory profit-sharing plan; it does not apply to forfeiture of vested shares the employee already owns.
3. Drennen and Haass can be reconciled based on some other distinguishing factor.
4. It ultimately doesn’t matter whether Drennen conflicts with Haass, because regardless of whether you call a forfeiture clause a non-compete or not, it still must be reasonable in scope.

In my opinion, no. 1 is the worst interpretation, nos. 2 and 3 are reasonable, and no. 4 is the simplest and best way to reconcile the cases. To understand why, let’s dig into these two cases and see how Texas courts have applied them.

Haass said a clause that functions as a non-compete should be treated as a non-compete

Haass involved an agreement between an accounting firm and one of its partners, Haass. The agreement had a liquidated damages clause requiring Haass to compensate the firm if he withdrew and took clients with him. Id. at 383. Haass left, opened his own firm, and clients followed. Id. at 384. The firm argued that the damages clause was not a non-compete, while Haass contended it operated as a non-compete and therefore had to be reasonable. Id.

The court agreed with Haass that the damages clause was effectively a non-compete. Writing for a 7-2 majority, Justice Gammage acknowledged that the damages clause did not expressly prohibit Haass from providing accounting services to clients of the firm. Rather, the clause provided that if Haas did compete, he had to pay the liquidated damages. Id. at 385.

Surveying case law from other jurisdictions, the Haass court said:

Most courts have analyzed such provisions as restraints on trade sufficiently similar to covenants not to compete to be governed by the same general reasonableness principles in order to be enforceable. Even those courts that have declined to treat such damages provisions as restraints on trade have required them to be reasonable to be enforced.

Id. (internal citations omitted). Noting that the reasonableness test in either case was essentially the same, the court concluded that “the view adopted by most courts, that such covenants should be subject to the same standards as covenants not to compete, is the correct one.” Id.

Haass cited two additional reasons for treating a damages clause as a non-compete. First, the court reasoned that “[i]f the damages provided are sufficiently severe, then the economic penalty’s deterrent effect functions as a covenant not to compete as surely as if the agreement expressly stated that the departing member will not compete.” Id. at 385. “The practical and economic reality of such a provision,” the court said, “is that it inhibits competition virtually the same as a covenant not to compete.” Id. at 385-86.

Second, Haass said treating the damages provision as a non-compete was consistent with the court’s prior cases. Id. at 386 (citing Henshaw v. Kroenecke, 656 S.W.2d 416 (Tex. 1983), and Frankiewicz v. National Comp Associates, 633 S.W.2d 505 (Tex. 1982)).

Applying the reasonableness standard for non-competes, the Haass court went on to hold that the damages clause was overbroad and unenforceable because it imposed an industry-wide exclusion.

Haass established two broad common-sense principles:

First, a contractual provision that does not expressly prohibit competition can still be a non-compete if it imposes a significant financial penalty for competing. The “practical and economic reality” of the clause is more important than the label.

Second, regardless of whether a contractual penalty is classified as a non-compete, it must meet the same reasonableness requirements as a non-compete to be enforced.

Following Haass, Texas courts treated forfeiture clauses as non-competes regardless of how the clauses were worded or labeled.

For example, in Valley Diagnostic Clinic, P.A. v. Dougherty, 287 S.W.3d 151 (Tex. App.—Corpus Christi 2009, no pet.), the forfeiture clause expressly stated that it was not a covenant not to compete, but the court was not persuaded. “Although the provision at issue here is a forfeiture clause and expressly states that it is not a covenant not to compete,” the court said, “the Texas Supreme Court has analyzed such clauses in the same manner as covenants not to compete because they share the same objective—to restrain a former employee from competing against the employer.” Id. at 155.

Drennen said a forfeiture clause triggered by the employee competing is not a non-compete

But then the Texas Supreme Court muddied the waters in Exxon Mobil v. Drennen, 452 S.W.3d 319 (Tex. 2014).

Drennen was an ExxonMobil VP who received restricted stock subject to the terms of an incentive program. Id. at 322. The agreements included both a New York choice-of-law clause and a forfeiture clause allowing ExxonMobil to terminate outstanding stock awards if the employee engaged in “detrimental activity,” which included becoming employed by a competitor. Id.

When Drennen left ExxonMobil and went to work for Hess, another large energy company, ExxonMobil cancelled Drennen’s outstanding restricted stock awards based on his employment by a competitor. Id. at 323. Drennen sued for a declaratory judgment that (1) the detrimental activity clause was a non-compete, (2) the non-compete was unenforceable because it was not limited in time, geographic area, or scope of activity, and (3) therefore ExxonMobil’s purported cancellation of the restricted shares was invalid. Id.

The Houston Court of Appeals held that the forfeiture provision was an unreasonable and unenforceable non-compete and refused to apply New York law because the result would be against fundamental Texas policy. Id.

The Texas Supreme Court disagreed and reversed. The court viewed the forfeiture clause as similar to the provision at issue in Haass. But the court did not interpret Haass as holding that a forfeiture clause is a non-compete. “While we ultimately determined that the provision in Haass was an unreasonable restraint of trade,” the Drennen court said, “we never concluded that the damage provision was, itself, a covenant not to compete.” Id. at 329.

Let’s pause on that point. Drennen’s interpretation of Haass is strained at best. The Haass opinion expressly stated that a forfeiture clause should be judged by the same reasonableness standard as a non-compete and then applied that standard to the forfeiture clause at issue. Haass, 452 S.W.3d at 385-87. The reasoning of Haass was that a forfeiture clause that functions as a non-compete should be treated as a non-compete. For Drennen to say that Haass never actually held that a forfeiture clause is a non-compete seems like an academic distinction.

But that was not the worst part. Drennen went on to say the following:

There is a distinction between a covenant not to compete and a forfeiture provision in a non-contributory profit-sharing plan because such plans do not restrict the employee’s right to future employment; rather, these plans force the employee to choose between competing with the former employer without restraint from the former employer and accepting benefits of the retirement plan to which the employee contributed nothing. See Dollgener v. Robertson Fleet Servs., Inc., 527 S.W.2d 277, 278–80 (Tex. Civ. App.—Waco 1975, writ ref’d n.r.e.). Whatever it may mean to be a covenant not to compete under Texas law, forfeiture clauses in non-contributory profit-sharing plans, like the detrimental-activity provisions in ExxonMobil’s Incentive Programs, clearly are not covenants not to compete.

Id. at 329 (emphasis added).

This sort of thing bothers me. The court pretends the issue is easy, cites one Waco case from 1975, and then gets the answer wrong.

In my view, a forfeiture clause conditioned on the employee competing is obviously a non-compete and should be treated as such. But even if I’m wrong, the Drennen court at least should have acknowledged there is a reasonable disagreement on the issue. Heck, three justices on the Court of Appeals ruled the other way, citing Haass in support of holding that the forfeiture clause was a non-compete. Is Drennen saying they’re just morons?

My beef is not so much with the result. It’s the way Drennen gets there. The court could have acknowledged that there are two reasonable arguments, discussed both sides of the issue, and then explained which argument it found more persuasive and why.

Instead, Drennen simply made the statement quoted above and then said “we hold that, under Texas law, this provision is not a covenant not to compete.” Id. 329.

But to the court’s credit, it added this important qualification: “Whether such provisions in non-contributory employee incentive programs are unreasonable restraints of trade under Texas law, such that they are unenforceable, is a separate question and one which we reserve for another day.” Id.

That statement is important because it acknowledges that a forfeiture clause, even if it is not a non-compete, may still be an unenforceable restraint of trade. Keep in mind, section 15.05 of the Texas Business and Commerce Code provides that all contracts in restraint of trade or commerce are unlawful. The Texas non-compete statute provides an exception to that rule for non-competes that meet the requirements of the statute.

So, Drennen leaves open the argument that, even if a forfeiture clause is not a non-compete, an unreasonably broad forfeiture clause is an unenforceable restraint of trade.

Buc-ee’s follows Haass and interprets Drennen narrowly

Drennen also leaves open the argument that a clause requiring forfeiture of vested shares the employee already owns is a non-compete subject to the requirements of the non-compete statute.

This distinction finds support in the one case Drennen cited for the distinction between a forfeiture clause and a non-compete, Dollgener v. Robertson Fleet Services, Inc., 527 S.W.2d 277 (Tex. App.—Waco 1975, writ ref’d n.r.e.).

Dollgener, decided long before enactment of the non-compete statute, held that a forfeiture provision in a noncontributory profit-sharing trust was not a covenant not to compete. Id. at 278-80. Thus, like Drennen, Dollgener did not involve forfeiture of vested shares the employee had already earned.

The Houston Court of Appeals recently applied this very distinction in Rieves v. Buc-ee’s, Ltd., 532 S.W.3d 845 (Tex. App.—Houston [14th Dist.] 2017, no pet.), a case I wrote about here. The court held that an agreement that imposes a severe economic penalty on an at-will employee for quitting must meet the reasonableness requirements for non-competes, even if the agreement does not expressly prohibit competition. Id. at 851. Quoting Haass, the Buc-ee’s court reasoned that the “practical and economic reality” of such a contractual penalty is that it inhibits employee mobility in virtually the same manner as a non-compete. Id.

The employer in Buc-ee’s cited Drennen for the proposition that a forfeiture provision is not a non-compete, but the Court of Appeals rejected this argument. Characterizing Drennen as a “choice-of-law case,” the Buc-ee’s court distinguished Drennen as involving “cancellation of future payments of unvested stock options that had been awarded but not delivered to Drennen, an ExxonMobil vice president, under a non-contributory profit-sharing plan.” Buc-ee’s, 532 S.W.3d at 852. One critical distinction was that “Drennen did not involve ExxonMobil seeking the return of Drennen’s salary or any stock options that had already vested.” Id. (emphasis added).

So, Buc-ee’s also supports the argument that Drennen does not apply to a contract requiring forfeiture of vested shares the employee already owns. This is interpretation no. 2 outlined above. It reconciles Haass and Drennen based on whether the forfeiture involves equity ownership interests that have already vested.

Is this the right way to reconcile Haass and Drennen? As a practical matter, we won’t know the answer until the Texas Supreme Court addresses the issue. When it is unclear whether two cases conflict or can be reconciled based on some distinguishing factor, the answer really depends on how the third case treats them. And we don’t have that case yet.

But we don’t need that third case to know that regardless of whether a forfeiture clause is classified as a non-compete or not, it must be reasonable. An unreasonably broad forfeiture clause would be an unenforceable restraint of trade. Haass and Drennen seem to agree on that point.

So, if an employer wants to use a forfeiture clause to discourage employees from competing, the lawyer who drafts the agreements should at least include reasonable limitations on the scope of competition that triggers the forfeiture. The safer course is to assume the clause will be treated like a non-compete, and to include reasonable limitations on time, geographic area, and scope of activity restrained.

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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.