Mysteries of Texas Non-Compete Law, Part 2: Reformation

Mysteries of Texas Non-Compete Law, Part 2: Reformation

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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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. 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.

Mysteries of Texas Non-Compete Law, Part 1

Mysteries of Texas Non-Compete Law, Part 1

Nineteen eighty nine, the number . . .

A big anniversary is coming at the end of the summer. Yes, August 1 will be the 38th anniversary of the debut broadcast of MTV, which kicked off with “Video Killed the Radio Star.”

But I’m talking about a different anniversary: the 30th anniversary of the Texas non-compete statute, which became effective just a few weeks later on August 28, 1989.

That was a long time ago. The #1 song that week was “Right Here Waiting” by Richard Marx. I was probably sweating through summer marching band practice at Crockett High School in south Austin, Texas. With no cell phone, no email, and no social media.

It was not long before the statute was amended—in 1993—but otherwise the statute has remained the same for 30 years.

Since that time, the Texas non-compete statute has traveled a long and winding road through the Texas courts. I won’t bore you with the details, but in those 30 years there have been hundreds of Texas appellate opinions applying the statute, including at least a dozen opinions from the Texas Supreme Court. Plus opinions by federal courts applying the Texas statute.

With so many judges writing so many opinions, you would think that any big questions about application of the Texas non-compete statute would be answered by now.

But you would be wrong.

It is surprising how many fundamental questions about Texas non-compete law remain unanswered 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 celebrate the upcoming 30th anniversary, I’m revisiting that topic. It will be like an MTV countdown, but with non-competes, and less spandex. I’ll pick the most important unanswered questions of Texas non-compete law, explain each one, and look at how some recent court decisions have tried to answer them.

To kick this off, I’m starting with 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.

It don’t mean nothin’

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.

Like Richard Marx said, I’ll be right here waiting.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC.

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.

 

Federal-Style Motions to Dismiss May Finally Come to Texas

Federal-Style Motions to Dismiss May Finally Come to Texas

What a Difference a Word Makes

Are you a Texas business, or a lawyer who represents Texas businesses? Get ready for federal-style motions to dismiss to become routine in state court litigation.

As reported here, the Texas House of Representatives recently passed House Bill 3300. With the change of a single word, the bill could bring the biggest change to Texas litigation practice since the adoption of the “new” discovery rules in 1999.

The bill would change Texas Rule of Civil Procedure 91a from “the court shall award costs and reasonable and necessary attorney’s fees to the prevailing party” to “the court may award costs and reasonable and necessary attorney’s fees to the prevailing party.”

This is important. It was already a big deal when the legislature originally mandated motions to dismiss in 2011, leading to the adoption of Rule 91a in 2013. For the first time, the Texas Rules authorized motions to dismiss groundless lawsuits. This moved Texas procedure closer to the more defendant-friendly practice in federal court.

But Texas defense lawyers largely refrained from filing motions to dismiss under Rule 91a. The rule had a “loser pays” provision requiring an unsuccessful movant to pay the responding party’s attorney’s fees. If you’re a defense lawyer, the last thing you want to tell your client is “sorry, we lost the motion and you’re going to have to pay the other side’s attorney’s fees.”

The new version of Rule 91a passed by the House would change that. If enacted, the change would give the judge discretion not to award attorney’s fees, making defendants much more likely to file motions to dismiss.

Want proof? Just look at all the motions to dismiss filed under the Texas Citizens Participation Act (TCPA), also enacted in 2011. That statute authorized motions to dismiss in certain cases but did not require the moving party to pay attorney’s fees if the judge denied the motion. This resulted in a tsunami of TCPA motions. More about that later.

To appreciate the significance of the change to Rule 91a, let’s back up a bit. Since the Swing Era, Federal Rule of Civil Procedure 12(b)(6) has allowed a defendant in federal court to file a motion to dismiss the plaintiff’s lawsuit for “failure to state a claim upon which relief can be granted.” This means you can ask the judge to dismiss a lawsuit—in whole or in part—on the ground that the plaintiff’s pleading on its face fails to state a valid legal claim. Most states have a similar rule.

But not Texas. Prior to Rule 91a (and the TCPA), a “motion to dismiss” was not even a thing under the Texas Rules of Civil Procedure.

There were some exceptions. You could file a motion to dismiss on the ground that Texas did not have jurisdiction over an out-of-state defendant. You could file “special exceptions” asking the court to dismiss a particular cause of action because Texas law doesn’t recognize it (like negligent infliction of emotional distress).

But outside of a few narrow exceptions like these, Texas procedure did not provide for a “motion to dismiss.”

This led to interesting conversations with non-Texas lawyers. Let’s say a New York law firm hired you as local counsel in a lawsuit filed in state court in Hidalgo County. “Should we consider filing a motion to dismiss?” the New York lawyer would ask. “Uh, we don’t really have motions to dismiss here,” you would say. “What?! That’s crazy!”

But in historical context, it was not so crazy. The absence of motions to dismiss was part of a broader Texas philosophy that every plaintiff should get his “day in court.” Traditionally, Texas law has been hostile to procedures designed to short-circuit jury trials. As the proverbial courthouse sign said, “No Spittin’, No Cussin’, and No Summary Judgment.”

Of course, that all started to change around the 1990s, with “tort reform” legislation and Republicans taking over the Texas Supreme Court. The direction of Texas law for the last three decades has been largely “pro-business” and anti-litigation. We want fewer lawsuits, and we want to dispose of them faster.

Rule 91a and the TCPA were in a sense just the latest wave in a broad effort to reign in what is seen as lawsuit abuse.

“Frivolous” Lawsuits

Is this a good thing? In theory, yes. But in practice, Rule 91a and the TCPA are trying to solve a problem that is largely unsolvable: how to quickly and inexpensively dispose of the non-frivolous nuisance case.

You may be thinking that “non-frivolous nuisance case” is an oxymoron. But it’s actually quite common. Let me explain.

First we need to distinguish between a “frivolous” lawsuit and a nuisance lawsuit. A frivolous lawsuit is the inmate claiming the prison cafeteria violated his civil rights by taking pepper steak off the Thursday night menu. It’s unreasonable on its face.

And Texas never needed a new motion to dismiss procedure to combat frivolous lawsuits. Texas already had two procedures—one in Rule 13 of the Texas Rules of Civil Procedure, the other in Chapter 10 of the Texas Civil Practice and Remedies Code—providing remedies for genuinely groundless lawsuits. But those procedures are rarely used, precisely because so few lawsuits are actually frivolous.

Most of the public doesn’t get this. They think frivolous lawsuits are common. But in over 20 years of Texas litigation practice, I don’t think I’ve had a single one.

By the way, the famous McDonald’s hot coffee lawsuit was not frivolous. I mean, reasonable people can disagree about whether McDonald’s should have been liable for keeping its coffee too hot, but the claim wasn’t frivolous. The lady wasn’t claiming she didn’t know coffee is hot. Google it.

When you think about it, it’s not surprising that frivolous lawsuits are rare. How many people are going to pay $250 an hour (at least) to have a lawyer draft and file a lawsuit that has no real chance of winning? Or how many lawyers working for a one-third cut of the recovery are going to waste their time filing a lawsuit they know will ultimately fail? Not many.

But wait, the savvy public says, you’re ignoring the fact that defendants will pay money to settle frivolous lawsuits so they don’t have to pay their lawyers to defend them. That’s why such lawsuits get filed.

Oh really? How many times have you actually seen that happen? How many insurance companies do you know that, when served with a frivolous lawsuit, say “let me get out my checkbook, how much money would you like?”

No, businesses and insurance companies are not falling over themselves to pay off plaintiffs who file groundless lawsuits. If they did, it would only encourage more.

The Problem of the Non-Frivolous Nuisance Lawsuit

Nuisance lawsuits are different. Defendants do pay to settle nuisance lawsuits, on the theory that it’s cheaper to pay a settlement than to pay your lawyer to litigate. Lawyers sometimes call these “cost of defense” settlements. And these cases are quite common.

But how are these nuisance lawsuits any different from the frivolous ones?

The difference is that a nuisance lawsuit has at least some grain of truth to it. That grain may be that if you accept the plaintiff’s allegations as true, there is at least some reasonable legal argument that the plaintiff is entitled to relief from the court. Or it may be that there is at least some evidence to support the allegations made by the plaintiff, even if nine out of ten juries would vote for the defense.

While I’ve never seen a truly frivolous lawsuit in my practice, I’ve seen plenty of nuisance lawsuits. Here are some examples, drawn from my actual experience plus a little imagination:

  • A homebuilder sues a competitor for copyright infringement because the competitor used a floor plan that bears numerous similarities to a floor plan the homebuilder created. The floor plan has unique features such as a large living room with a high ceiling adjacent to an open kitchen.
  • An employee of an oilfield services company never signs a non-compete, but when he leaves to join a competing company, his original employer sues for misappropriation of trade secrets, claiming the employee has knowledge of the company’s confidential customer list, which consists of oil and gas operators.
  • A consultant who was fired a couple months into his one-year contract claims he is owed an entire year of pay, when the contract expressly gave the client the option to terminate early.

These cases have two things in common: they are weak, but they are not entirely groundless.

What’s Wrong with Motions for Summary Judgment?

It’s hard to represent a defendant in this kind of lawsuit, because your client is so frustrated. “Zach, I don’t understand, why can’t we just tell the judge this claim is ridiculous?”

The problem, of course, is that lawsuits are about disputes. If we had some surefire trick to separate the good guys from the bad guys, we wouldn’t need judges, juries, and complicated rules of procedure and evidence.

“But Zach,” my client will say, “don’t they need evidence to back up their claims?” “Why can’t we tell the judge they have no evidence?”

The answer is yes, they have to have evidence, and yes, there is a procedure to tell the judge they don’t have any evidence. It’s called summary judgment. Like the Federal Rules, the Texas Rules of Civil Procedure allow a defendant to file a motion for summary judgment on the ground that there is no evidence to support the legal elements of the plaintiff’s claims. See Texas Rule 166a(i).

The benefit of a motion for summary judgment is that it avoids the time and expense of a trial. If the evidence doesn’t raise any genuine factual dispute, the judge can dispose of the case by summary judgment.

So what’s the catch? Why doesn’t summary judgment solve the problem of the non-frivolous nuisance case?

In a word: discovery.

Traditionally, the plaintiff has been entitled to take discovery before the court rules on a motion for summary judgment. Discovery includes production of documents, written answers to interrogatories, and depositions. If you’ve ever been in a lawsuit with the slightest level of complexity, you know that 90% of the time and expense is for discovery.

Oh, and there was a development around the 1990s that made the discovery process even more complicated and expensive. It was a little innovation called email.

Now the full context of Rule 91a and the TCPA is coming into focus. Discovery is time-consuming and expensive, and the proliferation of email has only made it worse. The procedures for dismissing frivolous cases (Rule 13 and Chapter 10) are not much help because so few cases are actually frivolous. The procedure for summary judgment doesn’t solve the problem because the plaintiff is usually entitled to take discovery first.

This is why people thought a Texas version of Federal Rule 12(b)(6) was necessary. You need a procedure for weeding out nuisance lawsuits before the discovery process. That’s what will cut down on the time and expense of litigation.

The Law of Unintended Consequences

Those of you who practice litigation already see where this is headed. Does a motion to dismiss procedure actually reduce the time and expense of litigation? Let’s consider a couple data points.

First, we need look no further than federal court to test the hypothesis. Here we have to be careful about our sample. We should exclude, for example, securities fraud cases. Motions to dismiss are the big event in securities fraud class actions. But there’s a special reason: Congress passed a heightened pleading standard that, essentially, requires a plaintiff to allege specific facts showing that the CEO knew he was lying when he said on the analyst call “we think the environment for our expansion into Brazil is looking positive.”

That’s unusual. In an ordinary federal case, all the plaintiff has to do is allege sufficient facts to establish a plausible basis for relief. And when a motion to dismiss is filed, the judge must assume for the purpose of the motion that those factual allegations are true. That means the vast majority of federal motions to dismiss get denied.

Mind you, this doesn’t stop lawyers from trying. BigLaw firms, especially, really like motions to dismiss. Drafting a motion to dismiss is the perfect project to assign to a less experienced litigation associate, who will then research the legal standards at issue, analyze whether the plaintiff’s pleading meets those legal standards, and draft the motion. That’s good for 5-10 billable hours (at least), not to mention the partner’s time for reviewing and revising the draft motion.

Then the plaintiff’s lawyers do the same type of thing to respond to the motion, the defense lawyers draft a reply to the response, the plaintiff’s lawyers sometimes file a “sur-reply” to the reply, the judge might hold a hearing, etc.

Bear in mind that the judge is going to deny the motion. I learned this years ago in a case before U.S. District Judge Sam Sparks. We thought there was a strong argument that one of the plaintiff’s state-law causes of action, on its face, was preempted by federal copyright law.

At a hearing Judge Sparks gruffly asked me, “why should I rule on this issue on a motion to dismiss instead of waiting for a motion for summary judgment?” My answer, in a word: discovery. I told him my client should not have to bear the expense of discovery regarding a claim that was legally defective. “Ok, you’ve got a decent point there,” he said. “Motion denied.”[1]

That kind of shows you how much Rule 12(b)(6) has reduced the time and expense of litigation in federal court.

But could the new Rule 91a be different in state court?

Again, we don’t have to speculate, because we have some data from a similar experiment. Remember the TCPA? It allows a defendant to file a motion to dismiss in certain kinds of cases (essentially any case where the claim is based on a defendant’s “communication” about a good or service). The plaintiff then has to offer evidence to support every element of his claims, before taking any discovery. So, the TCPA essentially functions as a pre-discovery motion for summary judgment.

A pre-discovery motion for summary judgment. Hallelujah! That’s exactly what we’ve been waiting for to combat the problem of the non-frivolous nuisance lawsuit.

But has the TCPA reduced the time and expense of litigation? Let me put it this way: I’ve given presentations on the TCPA, and when I pose this question to a roomful of lawyers, it’s sure to get big laughs.

They laugh because the last thing the TCPA has done is to reduce the amount of litigation. On the contrary, I’ve heard people call the statute a full employment act for appellate lawyers. Just look at the number of appellate decisions grappling with the TCPA.

One more anecdote will make the point plain: I recently called the court clerk in one of my cases to schedule a hearing on a motion. His first question: is this a TCPA motion?

No, the TCPA has not reduced the time and expense of litigation. And here’s a prediction. If House Bill 3300 becomes law, six months from now when you call the court clerk asking for a hearing, he’ll say in a knowing monotone, “is this a Rule 91a motion?”

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*Update: Want evidence that federal courts already have “motion to dismiss fatigue”? Check out this proposed local rule in the Southern District of Texas that would require lawyers to confer before filing a Rule 12(b)(6) motion:

Screen Shot 2019-05-10 at 6.53.07 PM

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC.

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] I’m paraphrasing, of course; I don’t have a transcript. And to be fair to the judge, he also grilled opposing counsel about why he included a state-court claim that seemed to be clearly preempted by federal law.

Can Your Business Avoid a Fraud Claim by Putting Magic Words in the Contract?

Can Your Business Avoid a Fraud Claim by Putting Magic Words in the Contract?

If you run a business and use contracts drafted by a lawyer, there’s a good chance you’ve seen a clause like this:

This Contract contains the complete agreement between Buyer and Seller concerning the sale of the Products and Services and replaces any prior oral or written communications between them. In entering into this Contract, Buyer is not relying on any representation made by Seller that is not stated in this Contract.

The first part is called a “Merger Clause.” The idea is that it “merges” all prior representations, understandings, and agreements into the written Contract. The second part is called a “Disclaimer of Reliance.”

The main point of the Disclaimer of Reliance is to prevent Buyer from making a fraud claim if the deal goes south. The word “fraud” sometimes intimidates non-lawyers, but the basic concept is simple: if you lie to someone in a business deal and they take action in reliance on the lie, that’s fraud.

One special flavor of fraud is “fraudulent inducement.” It sounds legalistic, but the idea is simple: if I lie to you to get you to sign a contract, that’s fraudulent inducement.

When a business deal goes bad, fraudulent inducement is a popular theory, for two reasons. First, if you prove fraudulent inducement you may be able to avoid all the self-serving terms the other guy’s lawyer put in the contract. Second, you may be able to recover actual damages and even punitive damages.

But once upon a time, a smart lawyer figured this out and put the Merger Clause and the Disclaimer of Reliance in the contract he drafted for his client. The hope was that these clauses would prevent the other party from later claiming fraudulent inducement. The idea caught on, and soon his form went viral.

So today, any time a client needs a contract, a lawyer is going to pull up some form that likely includes both a Merger Clause and a Disclaimer of Reliance. For simplicity, let’s focus on the Disclaimer of Reliance.

If a party to the contract tries to claim fraudulent inducement—either to get out of the contract or to try to get damages—the smart litigator representing the other party is going to say, “sorry, Disclaimer of Reliance.”

Not so fast. The equally smart litigator representing the party claiming fraudulent inducement has an ace up her sleeve too. The Disclaimer of Reliance is ineffective, she’s going to argue, because the entire contract—including the Disclaimer of Reliance—was induced by fraud.

Expecto patronum!

Of course, whether the seller actually lied to the buyer to induce him to sign the contract is almost always in dispute. But let’s assume for the sake of argument that the seller made material misrepresentations to the buyer that caused the buyer to sign the contract.

I know, this is Texas. Like Robert Earl Keen says, “nobody steals, nobody cheats.” But just as a hypothetical, what are courts to do with this common situation?

What Rule Should Apply to a Disclaimer of Reliance?

Let’s consider four different rules courts could choose:

A. A Disclaimer of Reliance has no effect on a fraudulent inducement claim.

B. A Disclaimer of Reliance defeats a fraudulent inducement claim.

C. A Disclaimer of Reliance is effective if, when signing the contract, the parties lit incense, struck a ceremonial gong, and recited the Latin phrase caveat emptor in unison.

D. It depends on the circumstances.

I know, choice C sounds silly, but stay with me.

Choices A through C have one clear benefit: they are what lawyers call “bright-line” rules.

Of course, there could always be a factual dispute about whether the incense was actually lit, or a legal dispute about whether the original public understanding of “gong” included a cymbal. But let’s put those quibbles aside. Choices A through C draw clear, bright legal lines that judges can apply with certainty.

But which outcome is more just? The case for Choice A is that “fraud vitiates everything.” The idea is that when one party fraudulently induces the other party to sign the contract, the whole contract is tainted. There is also a certain “realist” case to make for Choice A: the Disclaimer of Reliance is almost always standard “boilerplate” that was not specifically negotiated by the parties. So it should have no effect.

The problem with Choice A is that it tends to encourage more litigation and less certainty. Any party who regrets doing the deal can claim fraudulent inducement, even if the claim has no merit, and it can take months—or years—and thousands of dollars in legal fees to resolve that claim.

That’s why many lawyers—especially transactional lawyers—would pick Choice B: the Disclaimer of Reliance defeats the fraud claim. The rationale for B is that it may mean less justice in a handful of cases where there is real fraud, but overall it’s better for business if companies don’t have to spend time and money litigating fraud claims. Better to stick to what’s in black and white in the contract.

But there’s an obvious counter-argument to Choice B, too. If courts adopt a bright line rule that a Disclaimer of Reliance bars a fraudulent inducement claim, then everybody is going to put a Disclaimer of Reliance in their contracts (as almost everybody already does). Then you have effectively abolished the fraudulent inducement theory.

And what about Choice C, the incense ritual? No one would seriously pick Choice C, and the reason is obvious. Why should the parties’ legal rights depend on whether incense was lit and the gong was struck? Modern judicial decisions should not turn on such ritualistic formalism.

Ok, but isn’t Choice B effectively the same as Choice C? If we say that a business can avoid a fraudulent inducement claim simply by reciting the magic words “disclaimer of reliance” in the contract, is that really any different from the “gong” rule, in principle?

I think this very point—the reluctance to attach too much significance to “magic words”—is why most courts are going to pick Choice D: It depends. Courts recognize that, while a bright-line rule can provide certainty, reality is just too messy to pick one result that should apply in all cases.

That’s a less satisfying answer—especially for non-lawyers—but it’s an answer that allows courts to enforce contract terms generally, while recognizing that justice may require exceptions in some cases.

At least that’s the theory. Let’s look at a case study to see how it applies.

Big Trouble for Big Blue?

Lufkin Industries manufactures machinery and equipment for the energy industry. It needed to upgrade its business operations software, so it called a little company called International Business Machines, which I call “IBM” for short. IBM recommended its “Express Solution for SAP.”

Before the contract was signed, IBM represented to Lufkin that the Express Solution was a preconfigured system that could be implemented within four to six months and meet 80% of Lufkin’s requirements without any enhancements. Oh, and IBM knew this was false (allegedly).

Would you believe the implementation of the software system did not go well? On the day of the “go-live-ugly” (what a great term), Lufkin followed IBM’s instruction to deactivate its old system. But the IBM system didn’t work. Lufkin was unable to use the Express Solution to invoice customers, manage inventory, track orders, calculate payroll, or pay employees and vendors. In short, the system failure crippled Lufkin’s business.

A jury later found that IBM fraudulently induced Lufkin to sign the contract and awarded over $20 million in damages.

But guess what was tucked away in the IBM-Lufkin contract? That’s right, a Disclaimer of Reliance and a Merger Clause. Section 2 of the Statement of Work said:

In entering into this SOW, Lufkin Industries is not relying upon any representation made by or on behalf of IBM that is not specified in the Agreement or this SOW, including, without limitation, the actual or estimated completion date, amount of hours to provide any of the Services, charges to be paid, or the results of any of the Services to be provided under this SOW. This SOW, its Appendices, and the Agreement represent the entire agreement between the parties regarding the subject matter and replace any prior oral or written communications.

These were the facts of IBM v. Lufkin Industries, decided by the Texas Supreme on March 15, 2019.[1]

So what rule did the Texas Supreme Court apply to determine if this clause was effective?

In theory, the court applied a version of Choice D: It depends.

The court started by noting its decision in Italian Cowboy Partners that said a merger clause, standing alone, does not bar a fraudulent inducement claim. But a disclaimer of reliance, in contrast, can be effective: “a clause that clearly and unequivocally expresses the party’s intent to disclaim reliance on the specific misrepresentations at issue can preclude a fraudulent-inducement claim.”

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Bang a Gong

On the other hand, “[n]ot every such disclaimer is effective,” and courts “must always examine the contract itself and the totality of the surrounding circumstances when determining if a waiver-of-reliance provision is binding.” In other words, the court must look to both extrinsic and intrinsic facts concerning the contract.

The most important fact is whether the contract was a settlement agreement that resolved a lawsuit or other dispute. Under the Schlumberger case, a disclaimer of reliance in a settlement agreement will usually be effective to bar a later fraud claim. The idea is that there has to be a way for parties to sign an agreement that ends litigation with certainty.

But most business contracts are signed at the beginning of the relationship, before any dispute. In that case, the relevant factors include whether:

(1) the terms of the contract were negotiated, rather than boilerplate, and during negotiations the parties specifically discussed the issue which has become the topic of the subsequent dispute;

(2) the complaining party was represented by counsel;

(3) the parties dealt with each other at “arm’s length”;

(4) the parties were knowledgeable in business matters; and

(5) the release language was clear.

When two businesses negotiate a contract and lawyers are involved, factors (2)-(5) will almost always apply. And in most cases the second part of (1) will be true. It’s hard to see how there could be a genuine fraudulent inducement claim if the issue in dispute was not discussed before the contract was signed.

All of those factors were present in the IBM case. With at most one factor weighing against enforcement, the court said it had “no trouble” concluding that the factors supported a finding that the disclaimer of reliance was effective. “The parties negotiated the Statement of Work at arm’s length,” the court said, “they were both knowledgeable in business matters and represented by counsel, and the two clauses expressly and clearly disclaim reliance.”

The court didn’t say much about the first half of the first factor: whether the merger clause and disclaimer of reliance were negotiated terms or mere boilerplate. I think we can assume the latter. And I think the court’s silence on that factor tells us the court doesn’t care too much about it.

So, despite the IBM opinion’s touchy-feely language about multiple factors and “totality of the surrounding circumstances,” it comes pretty close to this “bright-line” rule: when two businesses represented by lawyers negotiate a contract that contains a clear disclaimer of reliance, there is no fraudulent inducement claim, even if the disclaimer is boilerplate.

I think the “factors” and “circumstances” language is intended to give the court some wiggle room to allow a fraudulent inducement claim in a truly egregious case, e.g. where the party duped into signing the contract is an unsophisticated consumer not represented by a lawyer. But in most business cases, fraudulent inducement is out in Texas.

As long as you said the magic words.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. This post is dedicated to 80s supergroup The Power Station. 

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] Int’l Bus. Machines Corp. v. Lufkin Indus., LLC, No. 17-0666, 2019 WL 1232879, __ S.W.3d __ (Tex. Mar. 15, 2019).

I Can’t Drive 25 (Requests for Production)

I Can’t Drive 25 (Requests for Production)

Senior Texas lawyers despair, the last vestiges of the “trial by ambush” era are being swept away like the Imperial Senate.

It looks like changes to the discovery rules are coming to Texas in 2019. Some of the changes will be significant improvements, while others will be less consequential tweaks. But there is one proposed change that is just a bad idea: limiting each side to only 25 requests for production of documents. More about that later.

The Discovery Subcommittee of the Texas Supreme Court Advisory Committee has been working on changes to the discovery rules for a few years now. I wrote about this two years ago in Proposed Changes to Texas Discovery Rules Threaten Law Firm Revenue. As I wrote then, the two biggest changes are requiring Federal-style initial disclosures and making communications with testifying experts undiscoverable.

These changes struck me as basically a good idea, with the potential to reduce gamesmanship and litigation expense. I say “reduce” because you’re never going to eliminate gamesmanship from discovery. This is litigation, after all. Plus, one man’s “gamesmanship” is another man’s proper use of the rules to protect his client’s interests.

In any case, the changes I wrote about—and others—may be coming soon. On February 11, 2019, the Discovery Subcommittee transmitted its recommended rewrite of the Texas discovery rules to the Supreme Court Advisory Committee.

I’ve only got five minutes, so I won’t try to cover all the changes, but here are some highlights:

  • Rule 190.4 would require a Federal-style initial conference followed by a discovery control plan and docket control order. I often find the initial conference a waste of time—it’s too early to address all those issues—but it’s relatively harmless.
  • Rule 192.4(b) would change “the burden or expense of the proposed discovery outweighs its likely benefit” to “the discovery sought is not proportional to the needs of the case.” In other words, the proposal writes proportionality into the rule, although proportionality is already implicit.
  • Rule 193.2(a) targets “prophylactic” objections: “An objection must state whether any responsive materials are being withheld on the basis of the objection.” This sounds like a good rule, but expect it to be routinely ignored.
  • Rule 194 would now require Federal-style initial disclosures. Unless otherwise agreed or ordered, both sides would have to serve them within 30 days after the defendant’s answer. For Texas practice, this completes the decades-long shift in philosophy from “trial by ambush” to putting your cards on the table from the start. Also, like the federal rule, the new rule would allow “a description by category and location” in lieu of actually producing the documents—I’ve never understood the point of this.
  • Rule 195.5(a)(4) would expand the scope of expert disclosures to be closer to Federal Rule 26.
  • Rule 195.5(c) would generally exempt communications with testifying experts from discovery (like the Federal rules–notice a pattern?). Overall, this is a good change for reasons I explained in my “Proposed Changes” post.
  • Rule 199.1(b) would add total hour limits for depositions (50 hours for a typical case).
  • Proposals for addressing ESI and spoliation are still being discussed.
  • Rule 196.1(c) would provide: “Unless otherwise stipulated or ordered by the court, a party may serve on any other party no more than 15 requests for production or for inspection in a Level 1 case or 25 requests for production or for inspection in Level 2 or Level 3 cases, including discrete subparts.” [record scratch]

Wait, what?! You’re telling me in a typical case I only get to serve 25 requests for production?

If you’re not a lawyer, or if you’re a lawyer who doesn’t litigate, that probably doesn’t sound unreasonable. But trust me, 25 requests for production is not a lot.

I’ve been practicing business litigation in Texas for over 20 years. That’s not as long as most of the people on the Supreme Court Advisory Committee, but it’s still a pretty good run. I don’t think I’ve ever had a case of even the slightest complexity where each side served fewer than 25 requests for production.

My fellow litigators understand that you don’t know what you’re going to get when you serve that first broad set of requests for production. And you usually don’t know what the real factual disputes are until you get some substantive documents from the other side and take one or two depositions.

That’s not all. It’s hard enough to get the documents to prove your claim or defense when the other guy is cooperating. When opposing counsel is actively trying to obstruct your efforts to get the documents you need, it’s even harder. For example, I had a fairly simple non-compete case where I had to serve about a dozen sets of requests for production because the opposing party was so slippery.

Surely I’m not alone. I’m a little surprised that the highly experienced litigators on the Supreme Court Advisory Committee would endorse a 25-request limit. I’d be curious to know how many of them have ever had a business lawsuit where 25 requests for production were adequate.

IMG_7223
Take my license, all that jive

Maybe they’ve seen too many cases with an excessive number of requests for production. But there is already an inherent reasonableness limit. Let’s say a party has already served 75 requests for production in three separate sets and then serves a fourth set of 25 more requests. If those requests are unreasonable or duplicative of prior requests, then the responding party can file a motion for protective order asking the judge to limit the number of requests. I don’t think anyone doubts the trial court judge’s discretion to grant a motion like that.

If, on the other hand, those new requests are relevant to issues in the case, reasonably tailored, and not duplicative of prior requests, I say they should be allowed.

But we must reduce the cost of discovery, right?

I’m all for trying to contain the cost of discovery. But it’s not the number of requests for production that is driving up the cost of discovery. In my experience, it’s really two things: (1) emails, and (2) fighting over discovery.

The impact of emails on the cost of litigation is well known. That ship has sailed.

The other factor that makes discovery so expensive is when the lawyers can’t get along. It’s really the discovery battles that drive up the cost. These skirmishes are usually the result of requesting lawyers serving unreasonably broad requests and/or responding lawyers making a litany of unreasonable objections. The problem is then compounded when trial court judges don’t want to get their hands dirty.

These are the main factors that make discovery expensive, not the number of requests for production.

I don’t know how to fix these problems. But I do know that limiting parties to 25 requests for production isn’t going to make lawyers more cooperative, and it isn’t going to change the fact that reviewing and producing thousands of emails is expensive.

If anything, this new speed limit is likely to increase gamesmanship and battles over discovery. If you only get 25 requests, your incentive is to make them broad. That’s going to lead to more objections and more discovery motions. And don’t get me started on arguing about “discrete subparts”; we already know from interrogatories how much time lawyers can waste on that.

Proponents of the limit will point out that you won’t need as many requests for production because the other party has to produce their evidence as part of the new initial disclosures. That’s a fair point, but it doesn’t help me with getting the documents I need to prove my case.

In fairness to the proposal, I also have to point out the preamble: “Unless otherwise stipulated or ordered by the court . . .”

That’s a good safety valve. It leaves the parties free to agree on a greater number of requests for production, and I expect a lot of litigants—especially in complex cases—will avail themselves of that option. And even if the parties don’t agree, the judge can order a greater number of requests if a party offers a good reason.

So the proponents of this revision would say, listen dude (that’s what they call me), you’re overreacting.

But I still don’t think we should start with the presumption that 25 is a reasonable number of requests for production. When the parties can’t agree, some judges are likely to fall back on the number in the rules. So if we’re going to have a number, it should be a good number. Even better, let’s have no presumptive limit and just rely on an inherent limitation of reasonableness.

That was the decision the Texas Supreme Court effectively made when it adopted the “new” discovery rules back in 1999, when I was a new lawyer and Gary Cherone was singing for Van Halen. Those rules limited the number of interrogatories a party could serve but left the number of requests for production open-ended.

The Supreme Court Advisory Committee should do the same thing now. Most of the proposed changes look good. Just take out that 25-request limit.

And May the Force be With You.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. He likes both David Lee Roth and Sammy Hagar. 

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.

Is a Non-Solicitation Agreement a Non-Compete?

Is a Non-Solicitation Agreement a Non-Compete?

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.”

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Whether an agreement is a “non-compete” shouldn’t depend on the label

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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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC.

*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).

Texas Trade Secrets 101 2.0

Texas Trade Secrets 101 2.0

Ready for an early Christmas present?

I originally published my “Trade Secrets 101” memo in Trade Secrets 101: What Texas Businesses and Lawyers Need to Know. I designed it to give Texas businesses and their lawyers a helpful overview of Texas and federal trade secrets law.

With generous help from lawyer Paul T. Freeman, I have now updated that memo. You can download the new version here.

Regrettably, the new version is longer. But it has significant improvements, including:

  • More case cites
  • A new section on TCPA motions to dismiss
  • Less of my unsupported editorializing

Finally, despite my general preference, the case cites have been moved to footnotes. Don’t @ me.

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IMG_4571

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.