When clients and friends approach me about problems they are having with non-compete agreements, I hear the same sentiments over and over again, “non-competes are not enforceable in Texas,” or that they are not enforceable because “Texas is a right-to-work state.” These ideas are simply untrue. From an employee’s perspective, this mistaken belief can get him/her sued for damages. From an employer’s perspective, this mistaken belief could allow its employees to steal its customers and open a competing business across the street. Under either scenario, the results may be costly.
The Truth about Non-Competes
First, you should know, that the fact that Texas is a right to work state is often misunderstood. This only means that under the Texas Labor Code, a person cannot be denied employment because of membership or non-membership in a labor union or other labor organization. It has nothing to do with non-competes.
It is true, however, that Texas law disfavors non-competes, or any other restraint on a person’s ability to work, but they are enforceable when certain statutory requirements are met.
For non-physician employees, a non-compete is enforceable if it:
(1) is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made; and
(2) contains 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 employer.
Each of these statutory requirements are addressed below. You should know that these requirements also apply to the enforceability of non-solicitation agreements.
1. Ancillary to or Part of an Otherwise Enforceable Agreement
The first requirement is somewhat ambiguous, and Courts have been battling over its meaning for quite some time. Most recently, the Texas Supreme Court held that a covenant not to compete is “ancillary to or part of” an otherwise enforceable agreement if the “consideration” given by the employer is “reasonably related to” an “interest worthy of protection.”
Courts have found that “interests worthy of protection” include: goodwill, confidential/proprietary information and trade secrets.
As for “consideration,” Courts have held that a promise, express or implied, and the eventual provision to an employee of specialized training, confidential/proprietary information, trade secrets, and customer lists is sufficient consideration to meet this statutory requirement. In one case, the Texas Supreme Court also held that stock options were sufficient consideration to meet this requirement because they were “reasonably related to” the goodwill of the company under the particular facts of that case. However, to date, no case has held that the mere payment of money, commissions or a salary is “consideration” which is “reasonably related to” an “interest worth of protection.”
Thus, the first lesson is that a non-compete, at a minimum, should state that the employee will receive specialized training, confidential/proprietary information, trade secrets, and/or customer lists, as consideration for the non-compete, and the employer should actually provide these items.
For a non-compete to be enforceable its restrictions have to be reasonable in: (1) time; (2) geographical area; and (3) scope of activity to be restrained, and (4) it must be limited to what is necessary to protect an employer’s business interests.
Non-competes can come in two forms. The first is where an employee is restricted from competing in a certain geographical area for a certain period of time (Time and Area). The second is where an employee is restricted from competing with the employer for its customers for a certain period of time (Scope of Activity).
A. Time and Area
Geographical restrictions must be minimized to only what is necessary to protect the business interests of each employer. Courts have upheld geographical restrictions of various miles from an employer’s business location, and in certain contexts, wider geographical restrictions have been upheld where the area covered constitutes the employee’s actual sales or work territory. However, extremely broad areas, including areas where an employee never worked, may not be enforceable.
Time restriction should also be tailored to the needs of each employer. Courts have found that time restrictions of one to five years were enforceable based on the circumstances of each case.
Further, the scope of activity restrained is also a factor here, as well as below. Thus, if the non-compete restricts the employee from working within the restricted geographical area in a field that is not competitive with the employer, then it may not be enforceable.
B. Scope of Activity
As an alternative to Time and Area restrictions, restrictions on an employee’s solicitation or provision of services to customers that he or she had contact with during his employment, may be enforceable. However, limitations which prohibit an employee from contacting customers with whom the employee had no contract, may not be.
This type of restriction must also be limited to a time period which is based on the needs of the employer in each case.
C. Determined on a Case-by-Case Basis
Ultimately, whether or not a non-compete based on time, area or scope of activity will be enforceable will depend on how well an employer can articulate a need for the restrictions in the non-compete, and whether or not a Judge will find that the restrictions are reasonable and necessary under the circumstances. In drafting non-competes, it is best to be conservative in the restrictions, otherwise, the non-compete may not be enforceable. A good non-compete lawyer will help employers weigh their business needs in the context of the requirements of the law. There are many case specific examples which may be helpful in making the employer’s determination. A good non-compete lawyer can also review the non-compete that an employee signed for enforceability.
3. What Happens to an Unenforceable Non-Compete?
An agreement which does not meet requirement No. 1 (is not ancillary to an otherwise enforceable agreement) will simply not be enforced. However, an agreement that does not meet requirement No. 2 (is not reasonable) will be reformed by the Court to set reasonable limitations, and will be enforceable going forward, however, the employer will not be able to recover any damages for acts of the employee prior to the reformation.
Either way, litigation is costly. As an employer, you will want to be assured that your non-compete is enforceable before filing a lawsuit. A good non-compete lawyer can help draft an employer’s non-compete/non-solicitation agreement to help maximize its enforceability, and review existing agreements for enforceability. Additionally, non-compete attorneys may send cease and desist letters to competing employees, and their current employers, who could be held liable for interfering with the non-compete agreement (called “tortious interference with contract.”)
As an employee, you will want to be assured that the non-compete you sign is not enforceable before you start competing. A good non-compete lawyer can review existing agreements for enforceability. If prudent, notice can be sent to the employer explaining the unenforceability of the non-compete, and warning that an employer who attempts to enforce an unenforceable non-compete agreement may be liable for attorneys’ fees under certain circumstances.
The Law Office of Jack Quentin Nichols in Austin, Texas, can help you in both circumstances, and represent you should litigation be necessary.
Disclaimer: This post is not intended as legal advice. Every circumstance is unique and different rules may apply to your individual circumstances. Please contact an attorney to discuss your individual circumstances before taking any action in regards to any of the information discussed herein.