Covenants Not to Compete In Texas - Back To The Future?

With the recent Texas Supreme Court decision in Marsh USA, Inc. v. Cook, the status of covenants not to compete (often called “noncompetes”) has drastically changed in Texas.[1] Or has it?

The Marsh Court held that a covenant not to compete is "ancillary to or part of" an otherwise enforceable agreement – and therefore –enforceable – if the business interest being protected (goodwill) is reasonably related to the consideration given (stock options). (Marsh at *41). This holding was another step in the Supreme Court backing down from previous opinions (especially Light v. Centel Cellular Co., 883 S.W.2d 642 (Tex. 1994), which seemed to require elements not present in the Legislature’s statutory enactments. (See, Texas Business and Commerce Code, Section 15.50, 15.51 and 15.52).

The Supreme Court also stated, several times, that it was not really making new law, but simply
interpreting the Business & Commerce Code per the intent of the Legislature.

What Does It Mean?

For one, it means that the enforceability of a noncompete no longer turns on whether you provided confidential information or specialized training to the employee. Nor does enforceability turn on the timing on the provision of confidential information, as some courts have held. This is not an unexpected turn as the Supreme Court has previously warned judges that “section 15.50(a) does not ground the enforceability of a covenant not to compete on the overly technical disputes that our opinion in Light seems to have engendered.” Alex
Sheshunoff Mgmt. Servs., L.P. v. Johnson, 209 S.W.3d 644, 655 (Tex.2006). However, many trial courts have persisted in holding employers to a higher standard than the statute in
enforcing noncompetes.

The new byword is, as the Supreme Court has previously stated, reasonableness. That is, are the terms of the covenant not to compete reasonable in balancing the rights of the employee to compete with the employer after leaving, and the employer’s interests in protecting its goodwill, confidential information or other interest worth protection. Marsh at* 26, citing Sheshunoff, 209 S.W.3d at 651. Increasingly, then, the Texas Supreme Court appears to be leaning in the direction of making noncompetes enforceable to allow Texas to compete in the Information Economy of the 21st Century.

Stated differently, a noncompetition agreement is enforceable if it is reasonable in time, scope and geography and, as a threshold matter, "if it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made." Marsh at *15, quoting TEX. BUS. & COM. CODE § 15.50(a). But the Court is careful to point out that this new interpretation, basically overruling Light, simply follows “the Act's intent to return Texas law on the enforceability of noncompete agreements to the common law prior to Hill.[2] Thus the Supreme Court goes “back to the future” and reinstates the former common law per the intent of the Legislature.

Drafting An Enforceable Covenant Not To Compete

So, what does all this legal mumbo jumbo mean to you and your business?

First, to be enforceable, your noncompete must be “ancillary to or part of an otherwise enforceable agreement at the time the agreement is made.” An agreement for “at will” employment, by itself, will not be sufficient to support a covenant not to compete.

However, an agreement to provide confidential information or specialized training will (where the information or training is actually provided) support such a covenant, if it is truly confidential information or specialized training. Moreover, as decided by Marsh, a noncompete “signed by a valued employee in consideration for stock options, designed to give the employee a greater stake in the company's performance,” meets the “ancillary or related to” standard of the Covenant Not To Compete Act.

Second, the noncompete must be reasonable. You are not going to be able to enforce a noncompete that says a man can’t work anywhere in the US for 5 years! Keep it reasonable and restricted in time, place, and scope, and it will probably be enforceable. Ask for the moon and you will be sorry!

The safest way to proceed is to seek professional counsel from a firm, like The Vethan Law Firm, that is experienced in drafting and enforcing covenants not to compete.

[1] 54 Tex. Sup. J. 1234; 2011 Tex. LEXIS 465 (publication status pending).
[2] Hill v. Mobile Auto Trim, Inc., 725 S.W.2d 168 (Tex. 1987).

Old Understandings Under New Management

I spoke with a friend of mine recently who is doing some part time programming work for his employer. My friend’s job doesn’t normally involve programming, so he and his employer never really discussed ownership, licensing, or even additional compensation for the software my friend is developing.

My friend said there was a possibility that he would market the software in the future, and didn’t think his employer would try to claim any ownership interest in the software as his employer is not in that industry and doesn’t know anything about software anyway. Most importantly, my friend explained, “my boss and I get along great.”

Although my friend may have a good relationship with the people in charge of his company right now, what happens if the company comes under new ownership or management and the boss he had an understanding with is no longer his boss? Or what if the company has financial problems and needs any assets it can claim?

Whether it’s the Trustee in Bankruptcy or a corporate hatchet man sent in to turn a company around, there are those who will claim and divide company assets with cold precision. It is much better to communicate and paper your “hand shake” deal, before the owner of the hand you shook has been replaced by a stranger’s. Contact an attorney today to help you protect your work.

The Accidental Partnership

You can’t accidentally form a corporation. In Texas, as in other states, there are forms that must be filed and fees that must be paid. A partnership, however, can arise without any formal agreement between the partners. Many businesses start without loans from banks, but rather with money from friends and family. The owner of the upstart business is well advised to make sure that any amounts owed by the business be classified as debt in writing, unless the owner wants every friend and family member as a potential partner. Without such records of debt, there’s nothing to prevent Uncle Pete from saying “Creditor?! Heck no, I own half the business! We’re partners.” This kind of costly confusion can be avoided by making sure that no creditor mistakes his note for an equity interest. After all, if and when the business takes off, the owner of an upstart business wants to be able to pay off the debt and make profit, not divide profits with a partner he never wanted.


-Collin J. Wynne