Simplifying Non-Compete Agreements (Three Simple Rules for Drafting Non-Compete Agreements)

This blog post started
as a simple idea: distill drafting a valid non-competition agreement down to
three simple rules. “Simplifying” Texas non-compete law however is akin to
domesticating a rampaging beast.

Few areas of Texas law
have as turbulent a history as the enforcement of covenants not to compete in
employment relationships. All too often employers find themselves with an
unenforceable non-compete agreement on their hands, and no protection from
competition by former trusted employees who know their former employer’s
secrets. And all too often, the primary reason employers find themselves in
this situation is because they tried to overreach when drafting the
non-competition agreement – by either making restrictions last too long, cover
too much territory, or apply to too many competing activities.

Every lawyer who
practices in this area should know the magic language enshrined in the Texas
Covenants Not to Compete Act:

… a covenant not to compete is
enforceable if it is ancillary to or part of an otherwise enforceable agreement
at the time the agreement is made to the extent that it 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 promisee.

Tex.
Bus. & Com. Code Ann. § 15.50(a).

And while the courts
and legislature have struggled over the meaning of that language ever since the
Act went into effect in 1989, ultimately, it boils down to three simple rules:

First,
the covenant not to compete must part of or related to an enforceable agreement.

Second,
the restrictions placed on the employee’s ability to compete must be reasonable.

Third,
the restrictions must not be greater than necessary to protect the employer’s business
interest.

First Rule.
If the employer has a written employment contract with his employee, the
written contract may include the covenant not to compete. In the case of a
written contract, the covenant is “part of” an “otherwise enforceable
agreement.” If there is no written employment contract, then a separate written
covenant not to compete will do so long as the covenant is related to
employment. The written non-compete is “ancillary to” an otherwise enforceable
agreement.

But,
there must be a little something extra, something given by the employer in exchange
for the employee’s promise not to compete. The promise of employment standing alone,
whether written or not, is never enough to make a covenant not to compete
valid. There must be something more. Courts have held that a promise to
provide the employee with access to confidential information, or specialized
training, is enough to make a covenant not to compete valid. The confidential
information or specialized training must relate to the employee’s work. That is
because what the employer is seeking to protect—its confidential information or
specialized training it provides—is reasonably related to an interest worthy of
protection. Stock options have also been held to be adequate to support a
covenant not to compete, because they are related to a business’ interest in
protecting its goodwill.  However, a promise
merely of extra money
, such as a raise or bonus, is most likely not enough
to make a covenant not to compete valid.

When drafting a
covenant not to compete, it is not necessary that it state that it is ancillary
to or part of an otherwise enforceable agreement, but the covenant should state
what consideration, such as access to confidential information or specialized
training, or stock or equity interest, is being given in exchange for the
employee’s promise not to compete, and further that the consideration is
related to the employer’s business interests and goodwill.

Rule 2.
When it comes to restrictions on an employee’s ability to compete, the
restrictions must be reasonable. Reasonable as to how long promise not to
compete will last, where the promise not shall be effective, and as to what the
promise prevents the employee from doing.

How
Long
?
Texas courts generally have no trouble enforcing covenants not to compete that
last 6-months, one year or even two years post-employment.  The longer a covenant not to compete lasts
post-employment, however, the more closely a court will scrutinize it. Though
non-competes of three and five years have been upheld, unless a business has a
compelling reason for a covenant not to compete to last for longer than one or
two years, it is best to play it safe and stay within the latter time frames.

Where?
The geographic scope of a covenant not to compete must also be reasonable. A
restriction that prohibits a national sales representative from competing
anywhere in the United States stands a good chance of being found to be
reasonable.  Likewise, a restriction that
prohibits a sales representative working only in Harris County, Texas from
competing in Harris County, Texas will also most likely be held to be
reasonable.  

However, a restriction
that prohibits a sales representative working only in Harris County from competing
anywhere in the United States stands a high chance of being found to
unreasonable because the salesman did not work anywhere other than in Harris
County. Additionally, a restriction that prohibits that same Harris County
salesman from competing anywhere in Texas may also be held to be unreasonable.  On the other hand, restricting that salesman
from competing in Harris and adjacent counties stands a much better chance of
being found to be reasonable. Additionally, geographic restrictions that prohibit
an employee from working within ten, fifteen, or twenty-five miles of an
employer’s place of business are generally upheld by Texas courts and are a
viable alternative to count-wide restrictions.  

Another viable
alternative is a prohibition on soliciting customers of the employer for whom
the employee has done work. Several Texas courts have rules such a restriction
is an acceptable alternative to a geographic restriction because the customers
can be identified. General rules of thumb:

1.     
Restricted to a limited area, e.g. 5,
10, 20 mile radius of employer’s business – high likelihood of being upheld.

 

2.     
Restricted from competing in County
where employer does business – high likelihood of being upheld.

 

3.     
Restricted from competing in County
where employer does business and adjacent counties –better than fair likelihood
of being upheld.

 

4.     
Restricted from competing statewide –
likely to be upheld only if employee’s duties take him statewide, and dependent
upon the scope of those duties.

 

5.     
Restricted from competing nationwide –
may be upheld only if employee’s duties take him nationwide, and dependent upon
the scope of those duties.

 

6.     
Restricted from soliciting customers of
the employer, good likelihood of being upheld if the employee provided services
to or worked with those customers, and the customers can be identified.

What?
The type of activity that can be restrained generally takes three forms: (1)
soliciting the employer’s clients or customers, (2) soliciting the employer’s other
employees, and (3) engaging in competing activities.

Restrictions that
prevent a former employee from soliciting his former employer’s clients and
customers are generally upheld by Texas courts. On the other hand, restrictions
that prohibit a former employee from soliciting his former employer’s future
clients or customers, or clients or customers with whom the former employee had
no contact, or soliciting clients or customers from areas where the former
employer plans to expand have generally not been upheld by Texas courts.

Likewise, restrictions
that prevent a former employee from soliciting his former employer’s current
employees are also generally upheld by Texas courts, but not restrictions that
prohibit a former employee from soliciting other former employees.

Restrictions that prohibit
an employee from engaging in competing activities, such as selling widgets if
the employer sells widgets, are generally upheld by Texas court, especially if
the competing activities are identified. “Employee shall not sell widgets” is
more likely to be upheld than “Employee will not compete with employer.”

Rule 3.
The restrictions must not be greater than necessary to protect the employer’s
business interest. Though the Act speaks of goodwill, I would suggest that
goodwill is, in and of itself, a “business interest.” What is meant by “necessary
to protect the [employer’s] goodwill or other business interest?” One way of
looking at the formula is that the restrictions must be related to protecting
the employer’s business. For example, a highly placed employee, say a
vice-president or director of marketing, may have access to his employer’s
marketing or pricing strategies, financial data or forecasts, or customer lists.
A covenant not to compete that effectively restricts the employee from using
that information to the employee’s advantage and to the employer’s detriment is
a business interest that would be protected, and meet the requirements of the
Act. A covenant not to compete for an employee who has access to trade secrets,
such as a manufacturing process or formula, also serves to protect the
business’ interest by protecting a valuable asset. Finally, equity ownership in
the employer’s business, such as stock options, incentive employees to put
forward their best efforts on the employer’s behalf, thus contributing to
increasing the employer’s goodwill. All of the foregoing have been recognized
by Texas courts as business interests worthy of protection.

Not all businesses are
equal, as they do not have the same kinds of business interests and goodwill to
protect. Each business is unique, as are the jobs held by their employees. A
covenant not to compete is not a “one-sized-fits-all” solution to protecting an
employer’s goodwill or business interest. The penalty for poorly drafted
covenant not to compete can be that it is declared entirely unenforceable, or
that it is re-written by a court that is not as familiar with the needs of the
employer in their particular industry. In a worst case scenario, and employer
can even find himself paying the former employee’s legal fees. For that reason,
the employer should also seek the advice of legal professionals when drafting
covenants not to compete.
 
To learn more about this issue and other topics go to our website at www.vethanlaw.com