EMPLOYMENT NEWS – NON-COMPETITION AGREEMENTS

Robin Foret
January 25, 2008 — 2,500 views  
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Non-competition agreements between employers and employees, as opposed to those included as part of the sale of a business or the purchase of substantial stock in a company, are generally disfavored as a restraint of trade that must be limited in scope to protect employees with unequal bargaining power. Nevertheless, most states recognize that under certain circumstances companies will have a legitimate interest in restraining employees from engaging in unfair competition with the employer after the employment relationship has ended. Although the rules differ from state to state, the general policy behind restrictions on such employer-employee arrangements is similar, and almost always entails the evaluation of these agreements for sufficiency of consideration and for reasonableness in the scope of the activities to be restrained. Generally, any restraint on competition in the marketplace must be related to the protection of an employer’s legitimate business interest, and must be no greater than necessary to protect that interest. I. Non-competition Agreements in Texas A. Consideration Requirement There are several types of arrangements that will be considered non-competition agreements (also known as covenants not to compete). For example, some covenants restrain the former employee from soliciting company clients, and others restrict the individual’s ability to work in a similar industry for a period of time. Regardless of the type of agreement, all non-competition agreements must meet certain requirements to be rendered enforceable. In Texas, section 15.50 of the Texas Business and Commerce Code requires that a non-competition agreement be “ancillary to or part of” an “otherwise enforceable agreement” and meet two conditions: “(1) the consideration given by the employer in the otherwise enforceable agreement must give rise to the employer’s interest in restraining the employee from competing; and (2) the covenant must be designed to enforce the employee’s consideration or return promise in the otherwise enforceable agreement.” Tex. Bus. & Com. Code §15.50; Sheshunoff Management Services, L.P., 209 S.W.3d 644, 648-49 (Tex. 2006). Therefore, the agreement itself must indicate that the employer has given consideration to the employee, such as confidential and/or proprietary information, which is worthy of protection after the employment relationship has terminated. In Texas, and some other jurisdictions, an employer’s attempt to use monetary consideration to support a non-competition agreement will be insufficient, and often leads to a determination that the agreement is invalid and completely unenforceable. This form of consideration given in exchange for the employee’s promise not to compete will not actually “give rise” to the employer’s need to restrain trade in the same way as an employee’s access to confidential and/or proprietary information, which unlike money is worthy of protection after the employment relationship has ended. Accordingly, Texas courts have generally held that the payment of money does not constitute adequate consideration to support a restraint of trade against a former employee. Light v. Centel Cellular Co., 883 S.W.2d 642, 647 (Tex. 1994). Some courts have taken a similar view with respect to stock grants, especially when the employee is not provided with a sufficient amount of stock to obtain a real ownership interest in the company. See Olander v. Compass Bank, 172 F. Supp.2d 846, 851 (S.D. Tex. 2001) (promise to provide stock illusory). B. Reasonableness Requirement When a covenant is supported by sufficient consideration, it will be further evaluated to determine whether the arrangement is reasonable. In Texas, for example, section 15.50 mandates that the non-competition clause contains limitations that are reasonable as to: (a) time; (b) geographical location; and (c) scope of activity to be restrained. This analysis is designed to insure that the restraint imposed is no greater than is necessary to protect the goodwill or other legitimate business interest of the company. See Sheshunoff 209 S.W.2d at 652. As is true for many other jurisdictions, Texas courts are generally amenable to a non-competition arrangement that restricts an employee from soliciting company customers and/or providing similar services to customers, if the employee has had contact with those customers while employed with the company. A reasonable geographical location is generally the areas in which the employee worked or made sales calls during the employment term. A limitation of two years or less on such activities will generally be considered reasonable; however, time periods that exceed two years will most likely be construed as unreasonable. The rationale here is that after about two years, the company’s customers will become comfortable with a new contact person. C. Reformation of Overbroad Provisions In Texas, if a non-competition clause is overly broad in scope, time or geographical limitation, a court will reform the clause by narrowing its scope so that it can be enforced against the employee. In fact, the Texas statutory scheme directs the courts to reform overbroad agreements by providing that “the court shall reform the covenant to the extent necessary to cause the limitations contained in the covenant as to time, geographical area, and scope of activity to be restrained to be reasonable” See §15.51(c). Texas is therefore referred to as a “Blue Pencil” state, as opposed to a “Red Pencil” state, which will simply invalidate as unreasonable any clause that is too broad in scope. Reformation is not without a down-side. When a court reforms a non-competition clause to make it reasonable, an employer may be limited to injunctive relief, and precluded from seeking damages for the employee’s violation of the overly broad provision. II. Non-competition Agreements in Other Jurisdictions Each jurisdiction has its own body of law on the issue of non-competition agreements. Most states, however, share in common the requirement that the restrictions on employees be no greater than necessary to protect the legitimate interests of the employer. See, e.g., Summits 7, Inc. v. Kelly, 178 Vt. 396, 886 A.2d 365, 369 (2005) (explaining modern approach of reasonableness); Abel v. Fox, 274 Ill.App.3d 811, 654 N.E.2d 591, 595-96 (reasoning of various jurisdictions discussed). Below are some examples of more recent trends. A. Training as a form of Consideration In addition to access to confidential and/or proprietary information, which is a widely accepted form of consideration in many states, some states recognize that specialized training (that which enables the employee to unfairly compete with the employer) may constitute adequate consideration for a covenant not to compete. See Borg-Warner Protective Services, Corp. v. Guardsmark, Inc., 946 F. Supp. 495, 501-02 (E.D. Ky. 1996) (Kentucky court found that specialized training in how to perform security guard services allowed the employees to compete in the industry, and served as justification to enforce a non-competition clause). To the contrary, ordinary on the job training will likely not be sufficiently specific to be considered specialized. See Dyer v. Pioneer Concepts, Inc., 667 So.2d 961, 964 (Fla. App. 1996) (Florida court held that training in stripping floors was insufficient to constitute specialized training that would give rise to a legitimate business interest); Vantage Technology, LLC v. Cross, 17 S.W.3d 637, 644 (Tenn.Ct.App. 1999) (ordinary day-to-day business/sales experience training will not suffice). In states that recognize training as a form of consideration, the employer must evaluate whether the type of training being provided is specialized enough to support the conclusion that without such training, the employee would not have been able to compete with the employer in the particular industry. B. At-Will Employees A number of jurisdictions, including Texas, recognize that continued employment by an “at will” employee (a situation in which either the employer or the employee may terminate the employment relationship at any time for any reason or no reason) may support enforcement of a non-competition agreement. In Texas, the burden will be on the employer to show that the employee in fact received information that qualified as confidential and/or proprietary in nature after the agreement was signed but before the employee left the company. See Sheshunoff, 209 S.W.2d at 648-49 (Texas case recognizing that at-will employees may be bound by non-competition agreements); Summits 7, 886 A.2d at 370-71 (several jurisdictions that have found continued employment of at-will employee to justify enforcement of non-competition clause listed), Copeco, Inc. v. Caley, 91 Ohio App.3d 474, 632 N.E.2d 1299, 1301 (1992) (result that precludes enforcement of non-compete agreement against at-will employee would lead to unfavorable result because the employer would be placed in a position of having to fire the employee). C. Blue Pencil vs Red Pencil Jurisdictions As mentioned above, some states like Texas will reform an overly broad non-competition clause so that it can be enforced to the extent reasonable (Blue Pencil states). See, e.g., Dyer v. Pioneer Concepts, Inc., 667 So.2d 961, 965 (Fla. App. 1996) (Florida court analyzed trial court’s reformation of clause to restrict geographical area to five counties); Hopper v. All Pet Animal Clinic, Inc., 861 P.2d 531, 540 (Wyo. 1993) (court concluded that reformation served public policy and explained legal debate on subject). Other jurisdictions, however, will not reform such arrangements. To be sure, these states take the position that overly broad non-competition clauses are unreasonable, and as such, may not be enforced. See Drumheller v. Drumheller, 204 Ga.App. 623, 420 S.E.2d 331, 334 (1992) (covenants not to compete that are overbroad taint the entire covenant so as to render it unenforceable); See Camco, Inc. v. Baker, 113 Nev. 512, 936 P.2d 829, 834 (1997) (Nevada court struck down as unreasonable non-competition agreement that was overbroad in geographical area). D. Reason for Termination Some states refuse to enforce non-competition agreements unless the employee voluntarily resigns his or her position with the company and/or is terminated in good faith. See Central Adjustment Bureau, Inc., 622 S.W.2d 681, 685 (Ky.App. 1981) (when employee continues to work for employer for an appreciable length of time and then resigns his employment, sufficient consideration exists and non-competition clause may be enforced). Wyoming, for example, requires that the employer show that the employee to be restrained was terminated from employment in good faith. See Hopper v. All Pet Animal Clinic, Inc., 861 P.2d 531, 544 (Wyo. 1993). III. Tips for Compliance Most jurisdictions recognize that non-competition agreements are enforceable against employees when narrowly tailored to protect a legitimate business interest. The use of overly broad language to cover every possible just-in-case contingency should be avoided. Instead, non-competition agreements should be drafted as narrowly as possible to provide the protection actually required by the company. Moreover, non-competition agreements are governed by state law, which means that individual state laws should be reviewed before drafting such agreements. Employers are advised to seek the assistance of legal counsel of their choice when considering the use and/or enforcement of non-competition agreements. The information contained in this article is not designed to address specific situations, and does not include rules and regulations that apply to all states . If you have questions concerning this topic, you should consult with legal counsel of your choice to obtain advice on various fact specific matters.

Robin Foret

The Foret Law Firm

Robin Foret practices in the areas of employment law, commercial litigation and specialty insurance defense claims. She handles a variety of employment matters such as theft of trade secrets, breach of employment agreements, non-competition agreements, wage and hour issues under the Fair Labor Standards Act (FLSA), discrimination and harassment issues under Title VII of the Civil Rights Act of 1964 (Title VII) and the Texas Commission on Human Rights Act (TCHRA), the Americans with Disabilities Act (ADA), Family Medical Leave Act (FMLA) issues, and the Sarbanes-Oxley Act (SOX). Robin has handled a wide variety of employment law matters for employers, as well as for executive-level employees, before agencies, and state and federal courts.