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Emerging from the Marsh: The Texas Supreme Court Clarifies and Solidifies the Enforcement of Non-Compete Agreements in the Employment Context
Dean J. Schaner, Katie Chatterton, Meghaan C. McElroy
Here we go again! For the third time in less than six years, the Texas Supreme Court has repudiated technical legal niceties and has adopted broad pro-employer principles to support the enforcement of non-competition agreements in Texas. Marsh USA, Inc. v. Cook, 54 Tex. Sup. Ct. J. 1234 (Tex. 2011). Eschewing footnotes and dicta from a prior opinion issued in 1994, the Court reasoned that an employer’s grant of stock options to an executive employee constituted sufficient consideration to support the enforcement of a non-solicitation of customers provision (in an employment agreement) against a former executive when he jumped ship to work for a competitor. The Marsh decision essentially demonstrates that confidential/trade secret information and specialized training are not the exclusive forms of employer-generated consideration necessary to enforce non-competition and non-solicitation of customer restrictions in Texas. And, in turn, the practical takeaway is that employers will find it far easier to enforce non-competition/non-solicitation agreements under Texas law.
My, how things have changed in the past decade. In 1994, the Texas Supreme Court emphasized the importance of a free market economy and warned employers that Texas courts should only enforce narrowly tailored non-competition agreements that satisfied procedural hurdles contained in a lengthy footnote. See Light v. Centel Cellular Co., 883 S.W.2d 642, 647 n.6 (Tex. 1994). Indeed, in the post-Light era, a majority of Texas courts reasoned that an employer must immediately give its employees confidential or trade secret information at the commencement of the employment relationship to support an enforceable non-compete agreement. Accordingly, it was fairly easy for a party challenging the enforcement of a non-compete agreement to demonstrate that no such contemporaneous exchange had occurred and, therefore, that any injunctive or other relief was unwarranted.
Recognizing the absurdity of the Light footnote and the peculiar results it spawned, the Texas Supreme Court, with the help of several litigants, embarked on a new course – why not recognize the practical necessity of non-competition agreements in the employment setting? Why not focus on more practical enforcement matters, such as the reasonableness of the non-compete covenant’s geographical, temporal, and scope of activity restrictions? That is precisely what the Texas Supremes did in several opinions issued between 2006 and 2010. See, e.g., Alex Sheshunoff Mgmt. Servs., L.P. v. Johnson, 209 S.W.3d 644 (Tex. 2006) (holding that simultaneous exchange of consideration was not required by Light and that a non-compete agreement could be upheld if the employer provided the employee with confidential information during the employment relationship); Mann Frankfort Stein & Lipp Advisors, Inc. v. Fielding, 289 S.W.3d 844 (Tex. 2009) (holding that an employer’s implied promise to provide confidential information, which could be inferred from an employee’s non-disclosure promise, was sufficient to satisfy the Light test).
Marsh represents yet another significant Texas Supreme Court retreat from the Light opinion in favor of a pro-employer proper balance, namely, arming employers with an enforcement mechanism to protect employer goodwill, confidential information, trade secret information and, potentially, other employer-generated benefits, such as long term incentive benefits.
The facts underlying Marsh presented the Texas high court with the perfect opportunity to repudiate some of Light’s odd footnote analysis. After several years of employment with Marsh, Marsh’s parent company granted Cook, a “key” company employee, stock options under its Incentive and Stock Award Plan. Like most long term incentive plans, the Plan was developed to provide valuable employees with the incentive to contribute to and benefit from the long term growth of the company. Before an employee could exercise a stock option under the Plan, the employee had to sign, among other things, a non-solicitation agreement. Consistent with this requirement, Cook signed a non-solicitation agreement when he chose to exercise his options. Under the agreement, if Cook left Marsh within three years of exercising the options, then Cook could not (i) solicit or accept business from Marsh clients with whom he had “business dealings” during his employment, (ii) solicit Marsh’s employees who formerly reported to Cook, or (iii) disclose Marsh’s confidential information or trade secrets.
Less than three years after exercising the stock options, Cook left his employment and began working for a direct competitor of Marsh, where he solicited Marsh’s clients and employees. Finding that the protective covenants were unenforceable, the trial court and court of appeals held that the transfer of stock did not “give rise to” Marsh’s interest in restraining Cook from competing.
Taking the opposite view, the Texas Supreme Court, in a six to three opinion, concluded that the restrictions against Cook were enforceable. The Court determined that under the Texas Noncompete Act, naked restraints of trade are unlawful; however, employers and employees are permitted to agree on reasonable restrictions that are ancillary to or part of an otherwise enforceable agreement having a primary purpose that is unrelated to restraining competition. TEX. BUS. & COM. CODE §§ 15.50-52. Thus, there must be an “otherwise enforceable agreement” between the parties and a covenant that is “ancillary to or part of” that agreement. Id. Further, a restriction (or, in pro-employer lingo – a “protective” covenant) must be reasonable in time, scope and geography. Cook and Marsh did not contest that an “otherwise enforceable agreement” existed – Cook agreed not to disclose confidential and trade secret information in return for the stock options Marsh granted him. The only question was whether Cook’s non-solicitation of customers promise was “ancillary to or part of” the otherwise enforceable agreement. But how do courts apply this test in the post-Light era?
“Ancillary to or part of” an “otherwise enforceable agreement.” Under Light, an employer essentially had to provide the restricted employee with consideration that “gave rise to” the employer’s interest in restraining the employee from competing. Light v. Centel Cellular Co. of Tex., 883 S.W.2d 642 (Tex. 1994). This strict requirement narrowed the interests the Noncompete Act would protect to confidential information, trade secrets, and specialized training – and effectively excluded goodwill and other potential forms of consideration as protectable business interests. Recognizing the need to remove this overly restrictive requirement, the Texas Supreme Court in Marsh re-emphasized that the focus of the Noncompete Act (and, thus, the enforceability analysis) should be on the reasonableness of the protective covenant’s restrictions. Further, given the absence of any textual basis in the Act for excluding the protection of goodwill, the Court upheld goodwill in the form of Marsh stock options as sufficient consideration to support Cook’s non-solicitation of customers restriction. The Marsh Court explained that the consideration for an enforceable non-compete agreement (here, stock options) must only be (i) reasonably related to the employer’s interest in (ii) protecting a legitimate interest, such as Marsh’s “goodwill.” Thus, the Marsh majority rejects Light’s amorphous “give rise to” requirement.
The Dissenting Opinion. The dissent accuses the court of creating a slippery slope where any financial incentive, such as salary increases tied to a promotion or cash bonuses given to an employee, could justify a non-competition agreement. Moreover, the dissent opines that the majority’s holding effectively overrules Light and abandons the previous application of the “ancillary to or part of” test in contradiction of the Texas Supreme Court’s precedent disfavoring non-competition restrictions.
Implications for Employers and Practical Considerations
The Texas Supreme Court has made it clear in Marsh that courts should not rule on challenges to the enforcement of covenants not to compete based on hyper-technical arguments and drafting disputes. Instead, the core inquiry is whether the protective covenant is reasonable and does not impose a greater restraint than necessary to protect the employer’s interest. Nevertheless, Marsh did not purport to answer all questions concerning the myriad forms of “consideration” that might support a non-competition restriction or protective covenant in the employment context. Accordingly, Marsh raises several practical points for employers:
- The opinion represents a pro-employer trend in which the Texas Supreme Court continues to chip away, if not obliterate, its confusing 1994 Light opinion (and even more confusing footnote 6) in favor of enforcing non-competition restrictions in the employment setting.
- Employers should carefully analyze all agreements between prospective employees and their former employers, focusing not only on employment agreements, but also on all stock option, long term incentive, and other incentive/benefits agreements. This thoughtful analysis will go a long way to avoid tortious interference and other claims against your company that a former employer may pursue when a valuable employee leaves the former employer to work for you.
- Employers may avoid costly non-competition and unfair competition litigation by implementing best practices/standards, including, without limitation, (i) incorporating proper offer letter language in which the new employee acknowledges compliance with common law and contractual fair competition law; (ii) training recruiters, human resources employees, and hiring managers to identify non-competition and other unfair competition issues; and (iii) consistently enforcing your own non-competition and trade secret provisions in your employment and incentive agreements.
- Employers should audit existing and prospective stock option and incentive plans and agreements to determine whether the employer desires to incorporate competition, solicitation, and recruitment covenants in stock option and other incentive agreements to protect an employer’s goodwill, confidential information, trade secrets, or other vital business interests.
- It remains to be seen whether stock options or other long term incentive benefits will constitute sufficient consideration to support non-competition restrictions for employees who are not considered “key” executive employees. The Marsh opinion emphasized (i) Cook’s status as a key or valuable employee and (ii) Marsh’s stock option grant to Cook as reasonably related to the company’s goodwill to support Marsh’s non-solicitation restriction. Post-Marsh, a host of open questions will focus on the sufficiency and value of the incentive compensation or other benefits that an employer may grant to an employee to support a non-competition or customer non-solicitation agreement in the employment setting.
If you have any questions regarding this Alert, please contact one of the lawyers listed below or visit the Haynes and Boone Labor and Employment Practice page of our website. You may also view the alert in the PDF linked below.
PDF - Emerging_from_the_Marsh.pdf