What are Non-Compete Agreements?
Non-compete agreements are sometimes referred to as covenants not to compete, and are contracts that restrict an employee or hired worker from doing business with a former employer’s customers or clients, or going to work for a competitor. Non-competes can also apply to businesses, either between a company and an owner, or between two business entities. Non-competes can be absolute or limited to geography, timeframe, or the type of product or service involved. These agreements typically include a provision prohibiting a former employee or business entity from soliciting the clients or customers of their former employer.
Employers may ask an employee to sign a non-compete agreement during the process of working out an employment arrangement. A non-compete is often part of a contract where the employer hires an employee and either sells the employee a franchise or enters into a licensing agreement to use a trademark. Employers sometimes add a non-compete to an employee handbook or orientation package , or require the employee to sign a separate document after they have been employed. Some businesses include non-compete covenants in various other types of contracts, including those with contractors, agents, or dealers.
One reason employers want these contracts is to ensure that an employee will not form a competing business based on information that could only be obtained at another company, or solicit clients, customers, or employees from that company.
Texas Statutory Framework for Non-Competes
In Texas, covenants not to compete are governed by Section 15.50, 15.51 and 15.52 of the Texas Business and Commerce Code and Chapter 180 of the Texas Occupations Code. Of those statutes which apply to non-compete agreements in Texas, non-solicitation agreements are subject to the Texas Business and Commerce Code Section 15.52. Texas courts generally enforce non-compete agreements if the agreement meets three specific requirements. The Agreement must: (1) Be ancillary to or part of an otherwise enforceable agreement between the parties, commonly referred to as a "covenant not to compete." (2) If the agreement is ancillary, it must contain limitations as to time, geographical area and scope of activity to be restrained that do not exceed what is necessary to protect the good will or other business interest of the promisee. (3) It must not impose a greater restraint than necessary to protect the goodwill or other business interest of the promisee and must allow the promisor a reasonable opportunity to return to that business.
Texas courts analyze non-compete agreements under the "rule of reasonableness," that is, a covenant not to compete must not impose a greater restraint than necessary to protect the legitimate business interest. Non-compete agreements in this State are generally void unless they contain at least five limitations which must be established before a Texas court may enforce the non-compete due to the fact that the Employer/Promisee has the burden of proof to convince the Court that they are otherwise reasonable. Examples of these limitations include, but are not limited to, a limitation as to scope, territory, duration, covenants, allowances for training costs, etc. The rationale behind the restrictive enforcement of non-compete agreements in Texas is that we, as a State, do not want to eliminate competition. The Texas legislature prohibits enforcement of non-compete agreements that might make it impossible for someone to work elsewhere. Remember that these limitations vary from jurisdiction to jurisdiction, and that some judiciaries may have stricter rules for enforcing non-competes than others.
Enforcement Standards in Texas
In Texas, there are four main criteria to consider for the enforceability of a non-compete agreement. A Texas company must be able to prove that:
- (1) the agreement is incidental to an otherwise enforceable agreement;
- (2) the covenant secures a "legitimate business interest";
- (3) the covenant imposes no greater restraint than necessary to protect that interest; and
- (4) the covenant does not impose greater harm on the covenant’s signatory than the benefit will be to the covenant’s signatory.
In addition to these general requirements for the enforceability of non-compete agreements, Texas courts also analyze the reasonableness of the restrictions imposed on the covenants. In order to be reasonable, the restrictions may not be greater than necessary to protect a legitimate interest. Courts also examine the reasonableness of the time period and geographic restrictions.
Remember, only a court can decide if your non-compete clause is enforceable. Even if your agreement has all the necessary criteria, an employee can challenge its enforceability in court and other litigation.
The lessons of this information should be clear. If you still have questions about what is required to create an enforceable non-compete agreement in Texas, it’s important to contact an experienced Texas business lawyer.
Scope of Restrictions
The extent to which a non-compete can restrict an employee’s future employment is subject to various limitations under Texas law. First, the clause must be "ancillary to or part of an otherwise enforceable agreement." A common example where this problem arises occurs when an employer wants to impose a non-compete on an employee after the employee has accepted a non-monetary benefit from the employer. If the non-compete is not supported by some independent, bargained-for consideration, the likelihood that it will be enforceable at all is very low.
In addition to this overall limitation, there are also some specific industries or professions that have unique restrictions under Texas law. For example, Texas occupations or professions are specific careers that have been identified by the legislature (such as physicians or attorneys) and are protected by specific statutory provisions that prohibit an employer from inducing someone to sign a non-compete. This type of statute does not technically make an otherwise valid non-compete unenforceable, but the existence of the statute is considered by the court when determining the reasonableness of the restraint in the particular circumstances. The phrase "specific occupation or profession" includes the following:
Attorneys and physicians are apparently exempted from the statute (in terms of the exception to the Hazard Rule) because they have their own statutes dealing with non-competes. However, there are certain professionals or skill sets that are regulated by statute and whose practice or profession is limited to the state issuing their license. Examples: pilot, engineer, attorney. In addition, the existence of certain other statutes requires a higher reasonableness standard for particular types of non-competes: Texas courts will generally look to the industry where the burden of proof lies on the party seeking enforcement of the non-competition agreement. Under the Texas statute related to the broadcasting industry, a non-compete is presumed unreasonable if it exceeds 90 days after the termination of employment.
The Role of Consideration
For any non-compete agreement signed after our Texas Supreme Court’s 2011 decision in Marsh USA Inc. v. Cook, a Texas employer must provide "consideration that existed when the non-compete was agreed to." Although this requirement initially caused confusion, the Texas legislature provided some clarity in 2015 by enacting Tex. Bus. & Com. Code § 15.003(b), which provides that: "consideration exists when an employer, or a person acting on behalf of an employer, provides access to confidential information related to the business of the employer of the person attempting to enforce the agreement, when the individual entering into the agreement agrees to the use or disclosure of the confidential information to the extent necessary to perform the services for, or represent or assist, the employer.
In other words, an employer can provide an employee two types of consideration to support a non-compete agreement: (1) confidential information and (2) access to confidential information. In short, this provision of the law states that an employee who has access to confidential information (and who agrees to abide by the employer’s policies on accessing or using confidential information) receives sufficient consideration to support a non-compete agreement. This rule, however, does not apply to non-compete agreements signed before the rule went into effect in 2015. For those not familiar with contract law, "consideration" is something of value that a party to the agreement gives another party in order to make the agreement enforceable. For example, cash in exchange for a car, boat, or house is consideration (and absent the money, you do not have an enforceable agreement). In the non-compete context, previously, Texas courts did not require much. The fact an employee agreed to abide by the restrictions, and was still employed for a period of time, was often all that was required for an enforceable agreement.
Texas Court Interpretations
Employers seeking to enforce non-compete agreements must be cognizant of Texas’s tendency to strictly construe the Davis factors. Prior to 2002, many Texas courts interpreting the Davis factors adopted a workable definition of the terms used in the Supreme Court of Texas’s 1965 decision in Texas & Pacific Railway Co. v. McGuire, 354 S.W.2d 926 (Tex. 1962). Specifically, many Texas courts focused considerable weight on the employees’ unique reasons for leaving their employer—such as the employees’ independent judgment, duress, or business necessity—and using these reasons to immaterialize the other Davis factors.
The Supreme Court of Texas, however, has consistently more narrowly construed these factors in recent years. The 2005 decision in Phoenix Surgical Supplies, Inc. v. Sarvesh Kumar Aggarwal, 182 S.W.3d 649 (Tex. 2005), demonstrates this stronger adherence to the Davis factors. In Phoenix Surgical, Dr. Aggarwal signed an agreement with Phoenix that contained a two-year non-compete provision. Phoenix then fired Dr. Aggarwal and, five days later , sent him a letter stating that he could continue working at the same hospital system but only under conditions that limited his scope of practice. Two days later, Dr. Aggarwal sent Phoenix a letter stating that he considered his termination wrongful and requested his final paycheck. Dr. Aggarwal thereafter began a practice with a direct competitor of Phoenix. In Phoenix Surgical, the Supreme Court of Texas reinforced that the proper measure of an employee’s own "independent judgment" as it relates to leaving an employer must focus upon the employee’s "economic incentive" rather than the employee’s subjective valuation of the benefits of working elsewhere.
Akin to Phoenix Surgical, many Texas courts have recently sought to limit their analysis of whether a means into an end (in the case of this Davis factor, an employee’s independent judgment) constitutes an "economic incentive." Thus, any additional factors that go into an employee’s decision to leave will generally not defeat the applicability of a non-compete provision.
How to Draft an Enforceable Non-Compete in Texas
Ensuring that a non-compete agreement is compliant with Texas law is the first step to having a better chance for enforceability in court. There are some best practices that Texas employers can try. As a matter of good practice, the non-compete agreement should be signed before the employee begins working with the employer, or if they are already working with the employer, should be signed before any confidential information or proprietary information is disclosed to the employee. This is to prove that the current employment situation is not sufficient consideration for the non-compete, but rather the only way the employee could get that information was if a non-compete was signed.
Another best practice is for the non-compete agreement to have a geographical area clearly defined. In Texas, geographical limitation is judged on the reasonableness of the area. For most people with the most common careers, a geographical limitation of anywhere from 50 to 100 miles is a reasonable limitation. If an employee lives in that area and at least some business in that area is available for purchase, it may be even more justifiable for the employer to have a non-compete agreement with that employee that prohibits them from doing business in that area, provided the agreement is otherwise compliant with Texas law.
Employers should include specific listed activities for the employee to promise not to do, rather than a blanket prohibition against anything that could be classified as competition against the employer.
Non-compete agreements should not be statewide in Texas. Although provisions in non-compete agreements have been shown to be valid, courts still will judge the reasonableness of that provision. A non-compete that is valid for the entire state of Texas would require showing that the business actually does business in every part of the state, which may not be true.
How to Challenge a Texas Non-Compete
There are numerous ways an employee or ex-employee may challenge an adverse ruling under a non-compete agreement in Texas. In fact many lawsuits are actually initiated by employees based on an employer’s unfounded assertions that the employee has violated some aspect of the non-compete agreement. In any event, the four most common legal suits or defenses that challenge the enforcement or interpretation of a non-compete agreement are:
- Lawsuit for Declaratory Judgment – Primarily this type of lawsuit is to determine whether some aspect of the non-compete agreement is enforceable or even properly formed. These types of lawsuits can be brought prior to an employer making some type of demand under the non-compete, as long as it is done prior to any breach. A declaratory judgment action is a way to bring about some certainty over a material issue that is subject to dispute.
- Breach of Contract – Suing for breach of a non-compete agreement usually involves the non-compete agreement being mutual and some type of damages arising from the parties breach. This can be premised on the company breaching the agreement first, or on an existing working agreement between the parties that was breached.
- Tortious Interference With Contract – This type of lawsuit involves suing the primary tortfeasor; in this case the employer or company that is seeking to enforce the non-compete agreement. The necessary elements of a lawsuit for tortious interference with a contract or prospective business relationship are that the actor had actual knowledge of the contract or relationship, the actor acted purposely and with intent to interfere, and the actor actually interfered. Finally the actor had to cause the damage or harm to the plaintiff. This type of claim and theory of liability does not apply to the non-compete agreement itself. In such cases, the employer or primary tortfeasor is actually interfering with the employee and former employer’s contract or relationship.
- Restraint of Trade – This type of lawsuit and series of legal claims are made against non-compete agreements and agreements and clauses limiting competition that are in restraint of trade. Generally these types of claims assert that the non-compete agreement is in direct violation of Statute and is not otherwise protected under the rules pertaining to reasonable competition.
Non-Compete Trends in Texas
The law on non-competes is constantly evolving and changing, and there are trends that can be spotted that signal what the law may say tomorrow. Future developments in the law governing non-competes in Texas could go in multiple directions. For example, the Texas legislature has recently given control of all non-compete disputes to the Texas Business Court (which has been a success and has resolved many disputes fast and efficiently), which means that future developments in the law will be someone less controlled by individual district judges.
Another potential change is that further "tethering" or additional regulation of non-competes and other restrictive covenants maybe on the horizon. There are what might be called "liberal" groups in the Texas Legislature who might introduce stricter regulation the covenants not to compete because, in their view, that encourages litigation and is bad for free enterprise. On the other side, we have business groups who oppose any additional regulation and seek deregulation by removing restrictions on physicians and other professionals from the restriction laws.
Future changes could go in either direction , but right now, the trend is toward a quieter regulatory environment. Public opinion also matters, and lower courts will be looking to the only research closely reviews the fortunes of non-compete system. An empirical study on non-competes with a mild anti-non-compete slant may motivate individuals and businesses opposed to the restrictive covenant system to pressure Legislators for change.
Also, in response to the above study, some law professors, law review editors, and others sympathetic to non-compete opponents have begun writing against non-competes in scholarly journals in order to build a body of law and policy that would eventually lead to judicial and legislative reform. This will take years, but those who are paying attention to this issue closely can see how it is evolving and creating the momentum needed to enact such changes.
Whatever the outcome is, it is likely that, if the current trend continues, Texas will become more business-friendly and only regulate the most egregious non-competes as antitrust matters and even deregulate physicians.