Gear Up Your Company’s Non-Compete Agreements

Employment contracts containing covenants not to compete have long been a touchy topic in Texas. Texas courts hold strong to a public policy position which strongly disfavors restraints of trade such as covenants not to compete. Accordingly, covenants not to compete must be carefully drafted to ensure they are enforceable under Texas law.

The price of failing to comply with applicable law, which derives from Texas’ Covenant Not to Compete Act, can be costly. Former employees are starting to beat their former employers to the courthouse door by filing declaratory judgment suits in covenant disputes. In these declaratory judgment suits, the employee asks the court to modify or completely revoke the covenant on the grounds that it is overbroad (as to time, geographical area or scope of activity restrained) or just plain unenforceable. According to a recent case, if the employee prevails in a declaratory judgment suit, it is much easier for him to win his attorney’s fees than if the former employer had instituted suit to enforce the covenant under the Covenant Not to Compete Act. So how do you determine if your company’s covenants not to compete are assets that will protect your company when employees leave rather than liabilities that will not hold up in court? While there is not one simple answer, the following questions will help you determine whether there may be some problems with your covenants:

1) What does the employee receive in exchange for his agreement not to compete with the company after he leaves?

If the answer is that he gets a job and a paycheck, without more, there are probably some fundamental problems. First, mere at-will employment will not support an agreement not to compete. In fact, many lawyers contend that a covenant not to compete can never be enforceable against an at-will employee (and Texas courts have not yet provided a clear answer to this question). If the answer is that the employee is provided with some type of specialized training, trade secrets or confidential information that is unique to your company (which is described in an employment contract) then the covenant may survive the first hurdle.

2) Does your company have a strong, legitimate, business justification for the length and nature of the restriction on the employee’s ability to compete?

The Covenant Not to Compete Act requires restrictions on the length of non-competition to be reasonable and no greater than is necessary to protect the company’s business. For example, it is doubtful that McDonald’s could ever demonstrate a legitimate justification for preventing one of its former fry-cooks from going to work at Burger King for even one day. On the other hand, Microsoft could probably demonstrate legitimate reasons for preventing a high-level executive from going to work for Apple for a period of a year or more.

Although court decisions as to how long the period can be are all over the lot, if your company’s covenants call for more than three months of post-termination non-competition, they may be considered overbroad absent a compelling business justification.

The geographical area of your covenant must be narrowly drawn as well. If your company only does business in Dallas County, a covenant restricting the employee from doing the same type of business anywhere in Texas is likely to be found to be overbroad. Due to the global nature of business today, many covenants now abandon a geographic scope restriction in exchange for a client-based restriction (i.e., the former employee may engage in the same type of business, but cannot work for or solicit business from any of the company’s clients).

The scope of the activity restrained must also be reasonable. If your company has thousands of current and former clients, a covenant preventing the former employee from working for or soliciting any current and former clients is likely to be overbroad. Instead, the restriction should be narrowed to prevent the employee from working for or soliciting any current or former client for which the employee actually performed work while he was employed by the company, or some other type of narrowing restriction.

If your company’s covenants do not meet the tests listed above, they likely face serious enforceability problems. Other factors that are beyond the scope of this article can also impact your company’s covenants. Given the unique approach Texas courts have taken over the last few years in interpreting such covenants, your company may want to have its covenants reviewed and updated to ensure they will prevent departing employees from making off with the company’s intellectual treasures.