Recent Non-Compete Case Teaches Importance of Providing Specialized Training

Recent Non-Compete Case Teaches Importance of Providing Specialized Training

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

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

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

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

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

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

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

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

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

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

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

Questions raised by tying a non-compete to specialized training

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Lessons Learned

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

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

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

______________________________________________________

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 has received specialized training on how to use phrases like “Comes now, Plaintiff” and “Wherefore, premises considered,” sometimes even in ALL CAPS.  

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

[1] Neurodiagnostic Tex, LLC v. Pierce, 506 S.W.3d 153, 164-65 (Tex. App.—Tyler 2016, no pet.).

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

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

[4] Neurodiagnostic, 506 S.W.3d at 171.

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

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

Texas courts are effectively ignoring the legislature’s command that restraints of trade or commerce are illegal

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

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

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

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

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

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

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

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

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

screen-shot-2016-09-25-at-7-41-28-am
Exxon Mobil v. Drennen elevated form over substance

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

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

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

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

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

screen-shot-2016-09-25-at-7-45-27-am
Connell v. Wells Fargo followed Drennen

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

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

Because the legislature makes the law, right?

_______________________________________________________________

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.

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

[2] Tex. Bus. & Com. Code § 15.05(a).

[3] Tex. Bus. & Com. Code § 15.50.

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

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