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

Employers should provide (and pay for) the cell phones and other PDA's used by their sales force.  Why?  So that the company is entitled to, and can insist on, the return of the telephone, the assigned telephone number and the contacts and other wealth of information contained on those devices when the employment relationship ends.  If a company allows an employee to use his or her own cell phone or telephone number (even if the company reimburses the employee for the service) , the company may not have a right to insist the telephone be turned over to it to clear the customer information from the phone.  Even worse, when your customers use the normal telephone number to place an order with their sales contact, who has since left your employment, they will be connected with your former employer who is now working for your competitor --and the employee didn't even have to do anything to solicit the customer's business for the new employer. 

Consequently, a comprehensive effort to protect confidential information, trade secrets and company goodwill may well include providing company-owned cell phones for the sales staff.

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In Part 1, I covered some thoughts on enforcing noncompetition agreements in Texas following the Texas Supreme Court's new decision in Marsh USA.  Today I'm addressing some tips that employees (and their representatives) who are asked to sign or are attempting to bust a noncompetition agreement might consider.

Prior to signing the agreement, negotiate everything you can.  For example:

• Carve out customers or clients the employee serviced before becoming employed by the employer requesting the noncompete.
• Seek very specific scope of activity restraint rather than a very generalized restraint (e.g., employee shall not engaged in any business that competes with any of the products or services of the company).
• Negotiate a garden leave provision (i.e., the employee will receive some amount of money during the term of the noncompete period)
• Ask for a buy-out clause where the employee (or his new employer) can buy out of the noncompetition agreement.
• Ask that the noncompete be automatically waived if the employers ends the relationship through no fault of the employee (e.g., the employee is laid off).

When joining a new employer, the employee should seek an agreement the new employer will indemnify, defend and/or advance defense costs if the employee is sued over an alleged violation of the noncompete.  The employee should also try and ensure that his employment will not be terminated by the new employer in the event he is enjoined over a restrictive covenant with a former employer (Don't laugh, I've seen an new employer provide this protection in an offer letter when it expected the former employer would sue the new hire).

When litigating over the terms of a noncompetition agreement:

• Emphasize to the Court how limited the holding in Marsh USA is.  Marsh USA just ruled out a per se rule that noncompetes tied to stocks are unenforceable.
• Emphasize the lack of imminent, irreparable harm.
• Determine the primary purpose of the agreement and emphasize to the Court that the real purpose is to stifle competition rather than protecting goodwill or confidential information.
• Identify lesser restrictions that will protect the employer's interest.
• Distinguish your client from the long-term, highly valued Managing Director in Marsh USA.

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Yesterday, Ryan Miller and I were invited to speak at the Tarrant County Bar Association's Labor and Employment Section luncheon.  Our topic was the recent changes to Texas noncompete jurisprudence.  A copy of the Power Point presentation we jointly presented can be accessed here.

For my contribution, I presented some thoughts on the practical effect the Marsh USA decision will have for employers and employees that dealing with noncompetes.  Here is a summary of thoughts:

REPRESENTING THE EMPLOYER USING NONCOMPETES

• Employers should continue to tie noncompetes to promises to provide confidential information and trade secrets to the employees and the employees' return promises not to disclose that information to third parties.  Trial courts are familiar with this concept and will expect it Marsh USA notwithstanding;
• Consider linking the noncompete to some financial benefit provided to the employee that is reasonably related (Marsh USA eliminates the "gives rise to" requirement of Light) to encouraging the employee to generate goodwill for the company.  Who knows how far courts will take Marsh USA, but bonuses, salary, for cause termination provisions, favorable parking spaces, fancy job titles, business expense accounts to entertain clients are a few examples of financial benefits that might be reasonably related to encourage employees to create goodwill that come to mind.
• Resist the urge to make the restrictions broader than necessary.  Courts have a statutory obligation to reform overly broad covenants, but any damages that accrue prior to reformation aren't recoverable.  Remember, reformation kills damages.
• Marsh USA isn't a magic bullet.  Marsh USA doesn't change the standard to obtain a temporary injunction (and there is where the battle often lies).  Employers still have to show probable right of success on the merits (arguably easier post-Marsh USA) and imminent irreparable harm.

In the next post, I'll cover my thoughts on what employees who may be subject to a noncompete might consider.

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Yesterday Rob Radcliff over at the Smooth Transitions Law Blog wrote a post about a lawsuit filed by an attorney against the recruiter that placed him at his new law firm.  In essence, the attorney alleged that the recruiter made representations that she was independent (and not tied to any particular law firm) and fraudulently convinced the attorney to join a Washington D.C.-based firm with whom the recruiter had a retainer relationship.  Radcliff warned recruiters about being explicit in representations made to potential candidates and disclosing who has retained the recruiter to avoid claims of misrepresentation and breach of fiduciary duty.

There is another area where recruiters need to be careful when conducting their search activities.  Recruiters need to be careful about where they place a candidate when they know the candidate has a noncompetition agreement that restricts the candidate's post-employment activities.  Recruiters can be sued for tortious interference with contract and/or conspiracy when the recruiter knowingly assists a candidate in violating his or her noncompetition agreement by putting the candidate in touch with a client company or for a position that would violate the terms of the candidate's post-employment obligations. 

On a few occasions, I'm aware of recruiters (and their search firms) who have been sued along with the former employee and the new employer over violations of a noncompetition agreement.  In those cases, the recruiters expressed shock and surprise that he/she could be held liable for assisting the candidate in violating the noncompetition agreement.  In one particular case, when the recruiter was asked whether she was concerned about putting a candidate with a noncompete in touch with a direct competitor (that was prohibited by the noncompete), she proclaimed, under oath, "That is just not something that I worry about!"   

As recruiters increasingly become entangled in disputes among competitors over enforcement of noncompetition agreements, the existence of a candidate's noncompetition agreement is probably something that recruiters should be concerned about.

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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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In Texas, at-will employees can prepare to compete against their current employers without violating the common law duty of loyalty.  Determining whether the line between lawful preparation to compete and unlawful competition begins is sometimes gray.  (See post).  A recent case from the Houston Court of Appeals provides a good summary of what an at-will employee can and cannot due within the bounds of a common law fiduciary duty of loyalty.  As the court summarized,

The Texas Supreme Court has recognized that fiduciary employees owe duties of loyalty to their employers and, if a fiduciary employee "takes any gift, gratuity, or benefit in violation of his duty, or acquires any interest adverse to his principal without a full disclosure, it is a betrayal of his trust and a breach of confidence, and he must account to his principal for all he has received." But an employer's right to demand and receive loyalty from a fiduciary employee must be tempered by society's interest in encouraging competition. Thus, in general, an at-will employee--even a fiduciary one--may plan to compete with his employer and take certain steps toward that goal without disclosing his plans to the employer, but he may not "appropriate his employer's trade secrets," "solicit his employer's customers while still working for his employer," "carry away certain information, such as lists of customers," or "act for his future interests at the expense of his employer by using the employer's funds or employees for personal gain or by a course of conduct designed to hurt the employer."

Whether Engel had a fiduciary duty to disclose the creation of the competing business Caputech and his plans to associate with Matrikon depends on what his job responsibilities were at PAS. If the fact-finder determines that his job responsibilities were those of a fiduciary, in dealing with his principal on a matter involving his own self-interest that would limit his employer's contractual rights, he owed a duty of full disclosure of all material facts.  If so, he could not legally put his interests above that of PAS "by a course of conduct designed to hurt [PAS]."

(Citations omitted).  If you are an employee considering leaving your current employer to start a venture that competes with your current employer, you should contact competent counsel to ensure that you do not cross the line from lawful preparations to compete to unlawful, unfair competition.

You can download a full copy of PAS, Inc. v. Engel here.

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I've had a chance to reread and digest the Marsh USA opinions over the weekend.  For those looking for easy ways to set aside or void noncompetition agreements in Texas, Marsh USA is strike three.  (Strike 1, Strike 2).  The Texas Supreme Court has, in the past five years, taken Texas from one of the more difficult states to enforce a noncompete to one of the easiest (so long as its reasonably limited).

Important Takeaways from the Opinions:

• Confirms that goodwill is a protectable interest worthy of protection through noncompetition agreement.
• Identifies contact with employer's "key customers" as a component of goodwill worthy of protection.
• Personal relationships and contact between customers and employees is goodwill of the employer that is protectable.
• Newly holds that nonsolicitation of employee provisions are subject to the Texas Covenant not to Compete Act.
• No requirement that employee receive the consideration for the noncompete prior to the time the employer's interest in protecting goodwill arises.
• Suggests that other financial incentives such as raises, bonuses or even a salary might be adequate consideration to support a noncompete if it can be established that such incentives enhance or protect employer goodwill.
• Recommends that trial courts conduct searching inquiries to determine whether the purpose of the agreement is improper protectionism or protection of goodwill (concurring opinion).

More from BusinessInsurance.com  Stock Options Offer Valid in Marsh Noncompete Dispute: Texas High Court.

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The Texas Supreme Court has issued an opinion this morning holding that noncompetition agreements supported by stock options and good will are not unenforceable as a matter of law.  I previewed this case here.  As I have time to digest the majority, concurring and dissenting opinions, I'll provide more thoughts on this case.

You can download the majority opinion here.

Concurring opinion here.

Dissenting opinion here.

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Many times one competitor sues another competitor over the hiring or two or more employees (whether over allegations of a breach of contract or misappropriation of trade secrets), the Complaint will make allegations of employee "poaching".  This gives rise to the question about whether Texas recognizes a cause of action for one competitor's poaching of another competitor's employees.  The answer is "yes" and "no." 

While there is no recognized cause of action called "poaching" for a competitor's targeting, soliciting and hiring groups of its competitor's employees (remember, Texas is a right to work state and restraints of trade are highly disfavored), there are recognized causes of action, remedies and tools available to employers who find their workforce the target of a competitor's poaching.  These include use of and enforcement of covenant not to competes; investigating and bringing claims for misappropriation of confidential information; theft of trade secrets; claims for unfair competition; breach of the duty of loyalty and fiduciary duty; tortious interference with contract; computer fraud and abuse; and conspiracy to tie together all the defendants acting in concert together.  

So while there may be no claim titled "poaching" under state law, there are recognized claims that can allow for an employer remedy against a competitor that has unlawfully targeted another competitor's employees.

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I've previously written about the specific requirements that must be included in a covenant not to compete with a licensed physician to make the restrictive covenant enforceable.  The Dallas Court of Appeals recently affirmed a trial court's decision that a noncompetition agreement between a surgical practice and several limited-partner physicians was unenforceable because the agreement lacked one of the statutorily required provisions.  You can access the Court's opinion in Greenville Surgery Center Ltd. v. Beebe here.  In short, the noncompete lacked the buy-out clause required by the statute.  That defect alone was sufficient to render the noncompetition obligation unenforceable.

Beebe should remind Texas employers that when drafting noncompetition agreements, it is important to have a knowledgeable, Texas attorney review the agreement before having employees or partners sign it.

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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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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 addition to containing reasonable restrictions as to time, geographic scope and scope of activity to be restrained, Texas imposes additional requirements for enforceable covenants not to compete with licensed physicians.  Those additional requirements include that the covenant: 

1. not deny the physician access to a list of his patients whom he had seen or treated within one year of termination of the contract or employment;

2. provide access to medical records of the physician's patients upon authorization of the patient and any copies of medical records for a reasonable fee as established by the Texas Medical Board;

3. provide that any access to a list of patients or to patients' medical records after termination of the contract or employment shall not require such list or records to be provided in a format different than that by which such records are maintained except by mutual consent of the parties to the contract;

4. provide for a buy out of the covenant by the physician at a reasonable price or, at the option of either party, as determined by a mutually agreed upon arbitrator or, in the case of an inability to agree, an arbitrator of the court whose decision shall be binding on the parties; and

5. provide that the physician will not be prohibited from providing continuing care and treatment to a specific patient or patients during the course of an acute illness even after the contract or employment has been terminated.

This legislative session, the law was amended to clarify that these additional limitations are not required to enforce a noncompetition agreement covering a physician's business ownership interest in a licensed hospital or licensed ambulatory surgical center.  (Link here).  An ambulatory surgical center is a facility that operates primarily to provide surgical services to patients who do not require overnight hospital care.  In connection with a physician's ownership interest in those operations, only the standard requirements for enforceability in the non-physician context apply. 

The additional physician-specific requirements for covenant not to compete enforcement appear to still apply to those licensed physicians who perform management or administrative roles within hospitals and healthcare facilities. The new law become effective September 1, 2009.

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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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