Covenant not to compete cases normally arise when an employer seeks to enforce a restrictive covenant by having a former employee enjoined from breaching the covenant and working for a competitor. They can also arise when the employee is not expressly prohibited from competing, but is subjected to severe economic penalty if he engages in competition. The recent case of Drennen v. Exxon Mobile Corporation from the Fourteenth Court of Appeals exemplifies the forfeiture scenario and the consequences that can arise when those programs do not comply with the Texas Covenant not to Compete Act.
In Drennen, the plaintiff worked for Exxon for 31 years. In August 2007, he tendered his retirement papers. During his employment, Drennen participated in Exxon’s Incentive Program that awarded restricted stock awards and bonuses to reward high-performing employees and to dissuade high-achieving executive-level employees from leaving Exxon to work for competitors. At his retirement, Drennen had 73,900 shares (approximately $6.2 million) of Exxon stock through the Incentive Program.
The Incentive Program allowed Exxon to cancel the employee’s awards if he engaged in "detrimental activity." Detrimental activity was defined, in relevant part, as the employee’s acceptance of duties to a third party that creates or appears to create a material conflict of interest and includes becoming "employed or otherwise engaged by an entity that regulates, deals with, or competes with" Exxon. The Incentive Program provided that New York law would be used to govern the agreement. The program also lacked any restrictions as to time, geographic area or scope of activity that might constitute detrimental activity.
After Drennen retired, he interviewed for a position with the Hess Corporation –a global, integrated energy company. Drennen informed Exxon that he was considering taking a position with Hess and Exxon warned Drennen that he would likely forfeit his incentive awards if he accepted the position. Nonetheless, Drennen accepted the job with Hess and Exxon notified Drennen that his incentive awards were canceled.
Drennen sued Exxon on a variety of theories. Exxon won following a jury trial. Drennen appealed arguing that the "detrimental activity" clause of the Incentive Program was tantamount to a noncompete that was unenforceable under Texas law. In reviewing the case, the Court of Appeals had to determine two interrelated questions: 1) is the detrimental activity clause a noncompetition provision; and 2) does New York or Texas law govern the interpretation of the program.
The Court first analyzed whether the enforceability of the "detrimental-activity" provisions differed under New York and Texas law. According to the Court, the "detrimental-activity" provision was enforceable under New York law (Drennen loses) but not enforceable under Texas law (Drennen wins). The Court reasoned that under Texas law, "covenants that place limits on former employees’ professional mobility are restraints of trade and are governed by the Covenants Not to Compete Act." According to the Court, the Act applies regardless of whether the agreement at issue expressly prohibits an employee from competing or subjects the employee to severe economic penalty if he engages in competition. Because the "detrimental-activity" provision subjected Drennen to a severe economic penalty if he competed (i.e., a forfeiture of over six million dollars), the Act applied. It was undisputed that the Incentive Program lacked limitations as to time, geographical area and scope of activity to be restrained.
Having determined that New York and Texas law differed in conclusion of the enforceability of the “detrimental-activity” provision, the court then made the outcome determinative decision of what law should apply. While noting that parties are frequently permitted to elect the law that will govern their transactions, the appellate court concluded that Texas rather than New York law applied because Texas has a materially greater interest in the dispute between the parties. Texas has a strong public policy interest in determining the enforceability of covenants not to compete used in this state. Drennen worked the majority of his career in Texas; he signed the agreements in Texas; he currently resides in Texas and Exxon is based in Texas. The court rejected Exxon’s argument that, as a large multi-national corporation, it has a stronger interest in uniform application of its employment agreements than Texas’s public policy interest because the Incentive Program at issue provides exceptions to New York law application for foreign-national employees that there was no showing that making other exceptions would significantly impede Exxon’s operations. Because Texas law dictated that the "detrimental-activity" provision was not enforceable the court ordered that Drennen’s awards be returned to him.
Because of the amount in controversy and the fact that the ruling likely impacts recipients of awards under an Incentive Program that is probably widely used (and has been in place since at least 1993), I expect that Exxon seek rehearing en banc or file a petition for review with the Texas Supreme Court.
You can download a full copy of the court’s opinion here.
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