Understanding the Non-Compete Agreements Enforceability in Texas
What Is An Non-Compete Agreement?
A non-compete agreement is basically just what it sounds like—a form of an employment provision or clause that places certain limitations on an employee. In most cases, a non-compete agreement will simply require an employee not to compete with their employer for some period of time after the employee leaves his or her job with the company.
Non-compete clauses are sometimes also called non-competition clauses or covenants not to compete, and they typically exist within a larger employment contract, although they could potentially be enforced through a standalone, separate contract as well. Such an employment contract would list the various duties and responsibilities owed by the employee to the employer, and the non-compete clause would simply make it clear that in the event of the employee’s termination, there are certain limitations on what the employee can do afterward .
Remember that there are many reasons businesses choose to employ non-compete agreements. For example, they often want to prevent current or former employees from starting their own businesses that are direct competitors to the business or taking jobs with competitor companies. This is particularly true of technology and software companies that have sensitive or proprietary information that would give their competitors a major advantage if released.
This is not limited to technology companies, however, and businesses in even a wide variety of industries commonly obtain non-compete agreements from their employees.
Legal Framework of Non-Compete Agreements in Texas
Texas has specific legal regulations governing the enforceability of non-compete agreements. In Texas, non-compete agreements fall within a body of law known as the "covenant not to compete" or what most people simply refer to as the Texas non-compete statute. The covenant not to compete is explicitly stated in the Texas Business and Commerce Code 15.50. The Contract Clause of the U.S. Constitution is the federal law that governs the legality of non-compete agreements but does not refer to those agreements by name. Federal courts evaluate the legality of non-compete agreements using the common law of contracts.
According to the Texas Business and Commerce Code 15.50:
Except as provided in Section 16.013, a covenant not to compete is enforceable if it is ancillary to an otherwise enforceable agreement and contains limitations as to time, geographic area, and scope of activity to be restrained that do not impose a greater restraint than necessary to protect: (1) the goodwill or proprietary interest of the promisee; or (2) an interest of the promisee protected by the common law of this state.
The Texas Legislature has by statute legislated what is required in order to satisfy the requirements that govern the enforceability of a non-compete agreement in Texas. As the Texas Supreme Court stated in the case Mann Frankfort Stein & Lipp Advisors, Inc. v. Fielding, Texas law renders non-compete agreements unenforceable until they are closely scrutinized against three statutory requirements. In Texas, non-compete agreements must:
In contrast, under the common law of contracts, there is no statutory requirement as to when a non-compete agreement may be enforceable. However, the common law of contracts does require enforceability to be reviewed on a case-by-case basis. As an example, the Texas Supreme Court in the case of Mann Frankfort stated:
We conclude that the restraint is enforceable because it protects the employer’s goodwill in its relationships with existing clients and because it is reasonably limited in time, geographic area, and scope. The trial court and court of appeals erred in concluding otherwise.
But the common law of contracts does not prohibit the enforcement of a non-compete agreement when the protectable interest is "proprietary," as the Texas non-compete statute requires. When a non-compete agreement prohibits the solicitation of a former employer’s customers, such agreement is enforceable without having a protectable interest in the goodwill of the business as long as there is mutual consideration between the parties to the non-compete agreement.
Requirements for Enforceability in Texas
In order for a non-compete agreement to be considered valid and enforceable in Texas, it must meet four requirements:
- (1) the agreement must be ancillary to an otherwise enforceable agreement;
- (2) the agreement must contain limitations as to time, scope, and geographic area that are reasonable and necessary to protect the goodwill or other business interests of the promisee;
- (3) the agreement must not impose a greater restraint than is necessary to protect those legitimate interests; and
- (4) the agreement must not adversely affect the public.
Each of these four requirements is discussed in more detail below:
The Agreement Must Be Ancillary to an Otherwise Enforceable Agreement
For a non-compete agreement to be enforceable in Texas, there must first be an underlying agreement that is itself otherwise enforceable. To satisfy this requirement, non-compete agreements must be ancillary to an exchange or amendatory agreement, and they must be drawn to enforceable business or other interests of the promisee. A non-compete clause may be ancillary to an otherwise enforceable agreement if it is part of, or attached to, an otherwise enforceable agreement. Since the statute applies to a non-compete that is ancillary to "an otherwise enforceable agreement," this analysis could result in a finding that the agreement, as a whole, is enforceable, rather than just the non-compete provision. See Tex. Lab. Code § 15.50.
The Agreement Must Contain Limitations As To Time, Scope, and Geographic Area That Are Reasonable and Necessary To Protect the Goodwill or Other Business Interests of the Promisee
The agreement must include specific limitations as to time, scope, and geographic area, and these must be both reasonable and necessary to protect the goodwill or other business interests of the promisor.
There are many factors that influence whether a non-compete is over-broad in its stated limitations, including the job title of the employee, the amount of time out of work that the employee had before being able to secure alternate employment, the customer clientele that he or she could service, and whether there are niche markets that the employee could use to pursue his or her business interests.
The Agreement Must Not Impose a Greater Restraint Than is Necessary to Protect Those Legitimate Interests
Implicit in this requirement is the notion that the public has a strong interest in fair competition. The net result is that, in most situations, the courts will seek to enforce the non-compete, provided that the restrictions it contains are reasonable under all of the circumstances. If the non-compete is drafted too broadly, the courts are much more willing to re-write or rework the agreement so that it is more reasonable relative to the job position of the employee.
The Agreement Must Not Adversely Affect the Public
Generally, non-compete agreements do not rise to the level that the courts find them to affect the public, and thus forbid their enforcement.
Exceptions and Limitations of Texas Non-Compete Agreements
As mentioned previously, the fact that a non-competition agreement is facially reasonable does not mean that a court must enforce it. Courts routinely invalidate non-competition agreements based on their own findings of unreasonable duration or geographic scope, or because the scope of the activity restrained is too broad.
Non-competes may also be rendered unenforceable based on the following exceptions:
• The rights reasonably necessary to protect the goodwill or other business interest of the employer. Limited enforcement is permitted in this situation.
• Unless otherwise invalid, a covenant not to compete is enforceable without regard to the circumstances of the sale.
• A non-compete agreement will be invalid where the statutory requirements have not been met or the employee’s willingness to compete has not been purchased.
• The non-compete agreement must be ancillary to an otherwise enforceable agreement.
• A covenant not to compete must be ancillary to the actual sale of an ongoing business.
• The agreement must contain limitations that are no greater than necessary to protect the business interest at stake.
• The agreement must be ancillary to the agreement to be enforced.
Recently Published Case Law Affecting Enforceability
In December 2019, the United States Court of Appeals for the Fifth Circuit considered the enforceability of a non-compete agreement under Texas law in the case of Twenty First Century Holmes Regional Medical Center, Inc. v. Health Systems of Florida, LLC, 922 F.3d 323 (5th Cir. 2019). The case addressed the question of whether a non-compete agreement violates public policy under Tex. Bus. Comm. Code § 15.50 when an employer and employee mutually agree to an extension of the time to respond to an initial offer to purchase the assets of the employer. The Fifth Circuit held that the agreement did not violate public policy.
The non-compete at issue prohibited the employee from competing directly with the employer for two years after termination or until the buyer of the business failed to perform under the terms of the asset purchase agreement, whichever event occurred first. During the sale process, the parties agreed to extend the time to respond to the original purchase offer while negotiating with other potential buyers. The employee ultimately rejected the offer to purchase the business and then began soliciting the employer’s clients in violation of the non-compete.
As a former Texas Supreme Court justice put it, statute "rather than common law, governs the enforceability of covenants not to compete in Texas." Alex Albright, Texas Covenants Not to Compete, 57 SMU L. Rev. 1197, 1220 (2004). Specifically, § 15.50 of the Business and Commerce Code requires that covenants not to compete comply with strict requirements, including consideration that is given "contemporaneously with the execution of the agreement." On the other hand, § 15 . 51 of the Business and Commerce Code allows parties to "alter, modify, or amend" the "asymmetrical advantages" acknowledged in § 15.50 by obtaining judicial reformation of their covenant not to compete.
In 2018, the Texas Supreme Court, in Marsh USA Inc., et al. v. Cook, 354 S.W.3d 764 (Tex. 2018), addressed the procedural approach to judicial reformation of covenants not to compete. The Court held that a party seeking reformation of a covenant must specifically plead and prove the elements required for judicial reformation of a non-compete to be enforceable. The Court also held that a party asserting a claim for reformation must pray for reformation in either the initial complaint (if filed before a motion to enforce the non-competition provision is filed) or by separate motion (if filed simultaneously with the motion to enforce the provision).
The Fifth Circuit, in the case discussed above, found the employer to have fulfilled its requirement to plead judicial reformation. The non-compete in question was included in a stock transfer agreement and mentioned that the employees’ recourse "shall be only at law or equity and . . . shall not affect the enforceability of the covenants . . . ." Further, the pleadings referenced the quasi-judicial prospect of limiting any remedy to monetary damages only. This prospective limitation to money damages is intended to give notice to a special master (previously called a referee in Texas) that the non-compete is unenforceable in its original form, but it may be reformed.
The argument that the employee’s acceptance of the extension of time to respond to the original offer was insufficient consideration to support reformation was expressly rejected by the Fifth Circuit.
Tips For Drafting Enforceable Non-Compete Agreements
When considering a non-compete agreement in Texas, there are a few strategies to keep in mind:
1. Hiring Legal Counsel: A non-compete agreement is a legal document and should be created with the help of an attorney to ensure enforceability in the event of a breach. Considering Texas case law, in particular, such step becomes even more important.
Two general principles can be gleaned from Texas case law. First, a non-compete that creates a covenant not to compete after termination of employment only is enforceable within the term of employment.
The basic idea of a covenant not to compete is to protect oneself from customers and other confidential information during the time of employment, not after termination. Thus, if and when a party should end, it would be illogical to restrict that party’s ability to make a living after the termination of such agreement. Courts are also likely to consider the term of employment when assessing the reasonableness of a non-compete.
For example, a three to five year term of employment is often seen as reasonable in many employment agreements, so a 5-year or longer non-compete agreement may seen as excessive. A one year or less term will likely be enforceable as being reasonable.
In addition, the restriction period after the termination of employment must also be reasonable as well. Thus, for example, in determining the reasonableness of a 2 year period of restriction, the courts will consider the period of restriction vis-à-vis the term of employment.
2. Specify the Territory of the Non-Compete: A non-compete only applies to a certain territory. The concept behind this is to restrict the ex-employee from making a living, yet at the same time not punish him or her incompletely.
A geographically small non-compete is more likely to be enforceable than a large geographical area. As a result, it is important to specify the territory covered by the non-compete agreement, especially if the company has expanded since the employment agreement was signed.
3. Consider Adding a Non-Solicitation Clause: A non-solicitation clause can be added to a non-compete clause to specifically list acts that are restricted. This clause should define the actions that are prohibited by the agreement.
A sample list of prohibited actions includes:
This list should be crafted with the help of an attorney, as it will have to anticipate every possible situation that may arise during the term of the non-compete. Moreover, the non-solicitation could have its own separate and more detailed provision, or it could be implemented in broad terms as part of the non-compete provision itself.
Considerations for Employers and Employees
Employers and employees alike should consider both the law and the factual context in Texas to determine if a non-compete agreement is appropriate. In deciding the scope of a non-compete agreement, employers should consider not only the legitimate interest that they are trying to protect but also the effect of the non-compete on the employee’s ability to earn a living in the relevant job market. Similarly, employees should consider the employer’s legitimate business interests that are sought to be protected as well as their own financial wellbeing in the job market. The basic rule of thumb is that the narrower the protections in the non-compete, the more likely it is that the non-compete will be enforceable.
For example, if an employer desires to prevent the employee from going to work for competitors, then the non-compete should limit the employee’s employment with competitors during a relatively short periods (e.g., approximately one year) and at least one geographical area that includes where the former employer competes. A non-compete that limits the employees ability to work for competitors in more than one metropolitan area, particularly if the geographic locations are substantially separated by other metropolitan areas (e.g., 10,000 miles away) is less likely to be enforceable. In determining reasonableness of a non-compete, Texas courts consider whether the non-compete protects the goodwill or confidential information of the employer. When a non-compete is narrowly tailored to protect the employer’s legitimate interest, the non-compete is more likely to be enforceable.
Consider the following hypothetical to illustrate further the point. Assume an employer engages in the retail sale of women’s shoes in Dallas, Houston, and Austin, Texas. Assume the employer has a legitimate business interest in protecting its goodwill in those cities. Further suppose the employer requires all prospective hires, who will be working alone in retail stores, to sign non-competes. The following are examples of reasonable non-competes under the factual scenario and examples of overreaching non-competes:
If a factually based employer is requested to sign a non-compete by a prospective employer that exceeds what is appropriate in the circumstances, the prospective employee should refuse to sign it with the hope that the employer will see the light. If the employer insists on an overreaching non-compete, then the prospective employee should consider whether working for the employer is worth giving up the right to earn a living in his or her field of trade.
Seeking Legal Help
Even if a non-compete agreement is not enforceable under Texas law, it can have a major influence on the future practices of a business, whether it’s enforced or not. Because of its importance , it is important to contact an attorney at the first sign of the dispute—if possible at the time the non-compete was executed—particularly for salt and pepper issues. A skilled Business Texas Litigator may be able to negotiate a separation from employment which will lessen the effect of the non-compete on your business.