Texas Employment Law Update : Texas Employment Lawyer & Attorney : Russell D. Cawyer : Kelly Hart & Hallman Law Firm : Dallas TX Labor Updates

In Part 1 of this two-part series, I examined the temporal, geographic and scope of activity restrictions for Texas physician noncompetition provisions.  Texas law provides another unique feature required only in agreements with doctors.  Noncompetes with physicians must include a provision that permits the doctor to buy-out of the noncompete for a reasonable amount. The buy-out can be determined at inception of the relationship by including an agreed liquidated buy-out amount or the parties can defer a determination of the buy-out amount and have an arbitrator determine the amount post-employment. What is a “reasonable amount” depends on the facts and circumstances but is normally an approximate value of lost profit the practice group would realize if the noncompete was not honored. Lost profits are determined by calculating the net income expected or actually made for the practice by the physician with appropriate adjustments for costs that would be incurred in earning that income. 

For liquidated (or agreed) buy-out amounts, an analysis should be done in arriving at the reasonable agreed amount. However, in practice, most employer groups and physicians merely choose arbitrary amount normally tied to a multiple of the physician’s annual income (e.g., a year or two of the physician's base salary).  This has little bearing on the actual value of the noncompete to the practice group. Moreover, the failure to conduct a buy-out valuation analysis prior to setting the liquidated buy-out amount may open the practice group up to allegations that it knew or should have known the buy-out amount was not reasonable and increases the likelihood the parties will have the arbitrate the amount of the buy-out. Moreover, this can also have an adverse effect on the practice group's ability to recover certain damages prior to a determination of a reasonable buy-out amount and may even allow the darting physician to recover his or her attorney’s fees.  Deferring a determination of the buy-out amount through arbitration at the end of the relationship can also result in the parties arbitrating the buy-out at a time when the relationship is most acrimonious (i.e., the end of employment).  For this reason, it is ideal to negotiate this amount at the beginning of the employment relationship.

The manner in which the buy-out amount is ascertained are all capable subjects to bargaining at the pre-agreement stage. For example, whether a  patient attrition rate will be used to lower the buy-out or will the lost profits be reduced by the amounts the practice group makes in mitigating its profits through the hiring or a replacement physician are a few examples of ways physicians can lower the buy-out amount. Minimizing the buy-out amount through negotiation increases the likelihood and feasibility that the physician can purchase his or her way out of the noncompete at the end of employment. Furthermore, decreasing the buy-out amount makes it more likely that a subsequent employer may pay some or all of the buy-out in order to be able to employ the physician from a competing practice group.

There is no end to the subjects of bargaining; however, the bargaining positions of the parties may not be comparable. Before entering into a noncompetition agreement that will restrict the right to practice medicine, the physician should retain experienced labor and employment counsel to advise and assist in minimizing the effects of the noncompete and buy-out clause.

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I’ve written before about the unique requirements that must be included in a noncompetition agreement with a Texas physician. The increasing likelihood that a Texas court will enforce a noncompetition agreement against any departing employee increases the importance that physicians and practice groups take great care in negotiating and drafting agreements with proper limitations as to time, geographic, scope limitations that are reasonable.  While no blog post is an adequate substitute for capable legal representation, this two part series is intended to outline some of the relevant issues that Texas practice groups and the physicians employ should consider before they sign an agreement restricting the doctor’s post-employment practice. 

The Texas statute requires that physician noncompetition provisions be reasonably limited in time, geographic scope and scope of activity to be restrained that are legitimate and necessary to protect the employer’s legitimate business interests and goodwill. Interests typically worthy of protection in medical practices usually include the employer’s confidential information, goodwill and referral sources. 

Determining the proper geographic scope of the restrictions can be done by looking as historical data from where the patients reside or the location where the referral sources are located (i.e., the doctors referring the patients to the practice group) that represent a significant amount of the practice group's revenue. Other options include whether the geographic scope is measured from the referring doctor’s office or the practice group where the physician signing the noncompetition agreement will practice. The importance of this designation will likely depend on whether the employer’s legitimate interests are in protecting its existing patient population or the referral sources from which it derives its new patients.

The proper temporal scope should be that amount of time it takes to recruit, hire and introduce to the referral community to the replacement physician. Some practice groups choose a year or two limitation while others choose the amount of time it took to recruit and hire the physician that is being hired and asked to sign a noncompete with some additional time added to account for the time it takes to introduce the new doctor to the medical community and referral sources. The more highly specialized practice (and conversely fewer number of qualified physician replacements) may justify a longer temporal scope of restriction. Conversely, practice areas that are less specialized or where there are an abundant number of replacement physicians eligible for hire, may only support a shorter noncompetition period.  

In the next post, I'll discuss the buy-out feature that Texas law requires to be included in every physician noncompete and that allows the physician to buy his or her way out of the noncompetition agreement.

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A trial court's order granting or denying a temporary injunction in a noncompete case is rarely reversed by the court of appeals.  This week the Fourteenth Court of Appeals took the unusual step of reversing a trial court's denial of an employer's application for temporary injunction seeking to prohibit a former employee from engaging in certain competitive activities.

In EMS USA, Inc. v. Shary, EMS brought suit against its former employee (Shary) to enforce the terms of a noncompetition agreement.  The agreement prohibited, in relevant part, Shary from soliciting any of the company's customers existing as of the date of termination.  The trial court issued a temporary restraining order and later held hearings on EMS's application for temporary injunction.  At two temporary injunction hearings the trial court did not take evidence but merely heard oral argument.  Shary argued that the noncompete was overly broad as a matter of law because it was not limited to the customers that he actually dealt with but instead included all customers existing on the date of his termination.  Without taking any evidence, the trial court concluded that EMS had not shown its entitlement to an injunction.

On appeal, EMS argued that the trial court abused its discretion in failing to take evidence addressing the reasonableness of the restrictions; whether the agreement should be reformed; and whether the restrictions were ancillary to or part of an otherwise enforceable agreement such as a personal services agreement. 

The Fourteenth Court of Appeals held that the trial court abused its discretion in denying the temporary injunction without first hearing evidence.  The appellate court found that the trial court should have heard evidence regarding the reasonableness of the restrictions; the circumstances surrounding the execution of the contract; and whether the former employee had dealings with all existing customers of EMS or only part of them.  Consequently, the court of appeals reversed the denial of the temporary injunction and remanded the case to the trial court for further proceedings.

A copy of the opinion is available here.

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In an unpublished opinion, the San Antonio Court of Appeals held that a former employee cannot avoid the effects of a noncompetition agreement under the doctrine of unclean hands, as a matter of law, when the inequitable conduct the employee complains of is separate from the issue in dispute.  (Opinion available here). 

In Central Texas Orthopedic Products, Inc. v. Espinoza, CTOP sued Espinoza after he resigned his employment and went to work for a direct competitor in violation of a noncompetition agreement he signed with CTOP.  Espinoza contended that the noncompetition agreement could not be enforced against him because CTOP had violated a separate Compensation Agreement by failing to pay all wages and commissions owed to him.  The trial court agreed and granted summary judgment for Espinoza.

The San Antonio Court of Appeals reversed the judgment for Espinoza and held that since CTOP's alleged failure to pay Espinoza did not grow out of the obligations outlined in the Noncompetition Agreement, the alleged breaches of the separate Compensation Agreement could not, as a matter of law, constitute an unclean hands defense to the noncompetition agreement.

Employees frequently try to avoid the effects of restrictive covenants claiming that the employer violated some obligation to the employees; thereby precluding the enforcement of the restrictive covenant under the doctrine of unclean hands.  CTOP continues the Texas judiciaries' trend of making it easier to enforce noncompetition agreements in the state of Texas.

Earlier:   Texas Supreme Court holds that Covenants Not to Compete that Contain Implicit Promises to Provide Confidential Information are Enforceable.

Texas Appellate Court Continues Trend of Enforcing Noncompetition Agreements.

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Since the Texas Supreme Court's Sheshunoff and Mann Frankfort opinions, Texas appellate courts have, with increasing frequency, enforced covenants not to compete in the employment context.  Gone are the days when noncompetition agreements were difficult to draft and enforce in Texas.

In Gallagher Healthcare Insurance Services v. Vogelsang, the First District Court of Appeals in Houston reversed a summary judgment to a former employee and rendered judgment in favor of the former employer on a breach of contract claim involving noncompetition obligations.  In Gallagher Healthcare, the former employee was employed as an insurance broker.  Her primary job was to renew existing business and secure new business.  After working for Gallagher Healthcare (or its predecessor) for twelve years, Vogelsang resigned and began working for a competitor.  Gallagher Healthcare sued to enforce its noncompetition agreement with Vogelsang that prohibited her from soliciting the clients she worked with during her last two years of employment with Gallagher Healthcare for two years.  The trial court found for Vogelsang and held that the covenant not to compete was not enforceable.  In reversing the trial court and rendering judgment in favor of Gallagher Healthcare, the court of appeals made the following significant conclusions.

• Two year prohibition from doing business with the 80 customers the employee dealt with during last two years of employment was a reasonable limitation.
• A customer limitation prohibiting contact with customers the employee did business during employment is an adequate substitute for a geographic limitation.
• Information given to the employee during employment was sufficient to give rise to interest worthy of protection and included:  financial information, customer information, employee salary information, client specific insurance information (e.g., insurance proposals, coverages, loss histories, exposures, limits, renewal dates, premiums, commissions and fee revenue), team related income and budgets, account retention strategies, at-risk accounts, strategic prospecting and selling, niche strategies, 2004 financial results, 2005 quarterly financial results, new and lost business summaries, professional standards audit results and related analysis, multiple types of prospect lists, premium volume comparisons, budget reviews, production reviews, internal committee lists and 2006 compensation plan.

The take away from Gallagher Healthcare, and other recent opinions, is that Texas courts are increasingly willing to enforce noncompetition agreements that are reasonably limited. 

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In a recent opinion of the Dallas Court of Appeals, the Court held that an insurance brokerage and consulting service firm’s noncompetition and nonsolicitation agreement obtained in return for an award of stock options to an employee was unenforceable under Texas law. (See opinion here).

Rex Cook was a long-term employee of Marsh USA, Inc. Prior to leaving his employment, Cook was a managing director. Cook was granted stock options in 1996 under Marsh’s Employee Incentive and Stock Option Award Plan. Before he exercised his options, Cook was required to sign a non-solicitation agreement that included a two-year covenant not to compete. In 2005 Cook exercised his options and in 2007 he left the company. Thereafter, he began employment with a competitor. Marsh sued the competitor and Cook. Cook asked the court to render judgment in his favor on the enforceability of the noncompete and the trial court held the agreement was unenforceable under Texas law. Marsh appealed that finding. 

On appeal, the Court explained that:

a covenant not to compete is enforceable if it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made and it contains reasonable limitations that do not impose a greater restraint than necessary to protect the goodwill or other business interest of the promisee. [citations omitted]. To be ancillary to or part of an otherwise enforceable agreement, a covenant not to compete must meet the following 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.

The Court then turned to whether the award of stock options to an employee “gives rise” to any interest worthy of protection for the employer. The employer argued that it uses stock option awards with its employees as a way to retain valuable employees; thereby protecting its goodwill (i.e., the relationship between the customer, employee and brokerage firm). The Court accepted the proposition that retaining valuable employees benefits a company’s good will but rejected the conclusion that such benefit gave rise to any interest in preventing the employee from competing. Furthermore, the Court reiterated that “financial benefits . . . do not give rise to an interest worthy of protection.”

As a result, the Court of Appeals affirmed the trial court’s grant of summary judgment to the employee that held that the noncompetition and nonsolicitation agreements obtained in return for an award of stock options was unenforceable. Marsh filed a petition for review with the Texas Supreme Court.

The take away from this case is that while covenants not to compete have become easier to enforce in Texas, the consideration that is given to the employee in return for the promise not to compete must give rise to some interest worthy of protection.  Money or other financial remuneration alone is unlikely to be sufficient.  Most frequently, valuable consideration to support a covenant not to compete will be in the form of a company's promise to provide its confidential information and trade secrets to the employee and the employee’s return promise not to use or disclose that information.  In that scenario, the promise to disclose the confidential or trade secret information (and the actual disclosure of that information) to the employee necessarily gives rise to an employer's interest in the noncompetition provisions.  

UPDATE:  On June 24, 2011, the Texas Supreme Court reversed the Dallas Court of Appeals and held that a covenant not to compete based on stock options given to a key employee to increase the company's goodwill were not per se unenforcable.  You can read more about the reversal and Supreme Court's new opinion here and here.

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