Non-Competition Agreements in Texas
Covenants not to compete (also known as non-competition agreements) are most commonly found in business sale contracts and employment contracts. Although most restraints on competition are unlawful under Texas law, the Covenants Not to Compete Act creates an exception for non-compete agreements. Under the Act, a covenant not to compete may be enforceable if it is:
- "Ancillary" to another enforceable agreement; and
- Reasonable 1
For the sake of simplicity in this article, we will use the term "Promisee" to describe the person who benefits from and seeks to enforce the covenant (typically an employer, or the buyer of a business.) The "Promisor," on the other hand is the person who makes the promise not to compete (usually an employee or the seller of a business.)
Standalone covenants not to compete are not enforceable in Texas; they must be "ancillary to or part of an otherwise enforceable agreement at the time the agreement is made." In order for the covenant to be "ancillary:"
- The consideration given must give rise to the Promisee's interest in restraining the Promisor; and
- The covenant must be designed to enforce the Promisor's obligations in the otherwise enforceable agreement.
Covenants in agreements for the sale of a business usually satisfy the ancillary requirement, but covenants arising in an employment context tend to be more problematic.
For many years, the courts required that non-compete agreements be ancillary to an agreement that was enforceable at the time the agreement was made. Light v. Centel Cellular Co. of Texas, 883 S.W.2d 642, 644-45 (Tex. 1994). This requirement made it extremely difficult to draft an enforceable non-compete agreement because most employment relationships in Texas are "at-will," and in an "at-will" relationship the employer can avoid its obligations by simply terminating employment. Thus, the courts reasoned, the employer failed the first prong of the "ancillary" test because it was not really giving anything in exchange for the employee's promise not to compete.
Non-competition agreements became much easier to draft and enforce with the 2006 case of Alex Sheshunoff Management Services, L.P. v. Kenneth Johnson and Strunk & Associates. There, the Texas Supreme Court held that an employer's future promise could form an "otherwise enforceable agreement" so long as the employer actually makes good on the promise. Just three years later, the Texas Supreme Court expanded the law again in Mann Frankfort v. Fielding, holding that the consideration need not even be explicitly promised, so long as it could be inferred given the nature of the employment. In 2011, the Supreme Court relaxed the standard even further when it held in Marsh USA Inc. v. Cook that stock options given to the employee in exchange for a non-competition agreement were reasonably related to the employer's interest in protecting its goodwill. Prior to Marsh, most lawyers believed that money or other financial incentives would never support a noncompete.
Even now, however, the consideration given by the Promisee must still "give rise to" the Promisee's interest in restraining the Promisor. Basically, this means that the Promisor has to receive something that would give him a competitive advantage compared to the Promisee's general competitors. For example, when the Promisee agrees to give the Promisor access to trade secrets or other confidential information, he has a legitimate interest in ensuring that information is not disclosed to a competitor. However, if all the Promisee gives up is information that is available from other sources, or a promise to provide a particular notice of termination, or even cash, the covenant will likely fail this test because none of these things give the Promisee any competitive advantage.
In addition to the "ancillary" requirement, the covenant must contain "limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the Promisee." Unfortunately, the court decisions do not provide uniform rules concerning what restrictions are reasonable. In fact, limitations that are found to be reasonable in one case may be unreasonable in another. However, some rules of thumb apply:
- The covenant's duration should relate to the business needs. For example, a Promisor under a one year contract might validly be subject to a one year non-competition covenant. Likewise, if confidential information provided to the Promisor has real value for two years, then a two year non-competition restriction might be valid.
- The geographical limitations should generally be no greater than the area in which the Promisor worked. However, at least one non-compete covenant prohibiting the Promisor from soliciting customers with whom he had contact while in the Promisee's employ has been upheld even without a geographic restriction.
The best advice here is not to get greedy. The covenant should be drafted as narrowly as possible in order to serve the Promisee's legitimate business needs.
Even if a non-competition agreement is overbroad, it may not be invalid. Instead, a court has the power to reform (re-write) the agreement to impose no greater restraint greater than necessary to protect the legitimate business interests of the Promisee, and then to enforce the agreement as reformed.
In most cases, the successful Promisee will be entitled to enforce the non-compete agreement by an injunction, which is a court order commanding the Promisor to do (or refrain from doing) a certain act. In some cases, the Promisee might also be entitled to recover money damages, attorney's fees, and court costs.
A great deal is at stake for both parties to a non-compete agreement. In the case of an employer or the buyer of a business, the economic viability of the enterprise may depend on its ability to prevent someone from using "inside" knowledge against it. On the other hand, the agreement limits the ability of the employee or business seller to make a living. These weighty considerations play out against a backdrop of laws that have been substantially revised over the years, and that have not been uniformly applied. This is one area where using an outdated form, or one from another state, could have disastrous consequences. To make matters worse, these agreements are often drafted as an afterthought, and presented to an unsuspecting employee with some sort of "sign it or take a hike" ultimatum. In our estimation, if the agreement is worth doing it is worth doing right.
If you need to discuss a non-competition agreement or other business-related issue with a business lawyer in Killeen, Texas, we would welcome the opportunity to consult with you.