Non-competes (also commonly referred to as covenants not to compete) are agreements contained in employment contracts whereby the employee promises not to open a competing business or go to work for a competitor, both during his or her employment, as well as for an additional amount of time post-employment.
Many employers require key employees and executives to sign non-competition agreements as a condition of employment. The limitations placed on employees in non-compete agreements are meant to protect an employer’s goodwill by preventing an employee who has extensive knowledge of an employer’s business practices and confidential information from leaving his or her employment and immediately using that information to go into business against the company.
Because of the restraints that non-compete agreements place on workers’ mobility in a free market economy, many states have enacted laws placing limits on their enforceability or voiding them altogether under certain conditions. In states that do permit employers to utilize non-compete agreements, many courts disfavor them and will either modify or “blue-pencil” the agreement to make it conform with statutory constraints (generally some sort of “reasonableness” standard as described in more detail below).
Recently, the State of Washington enacted a law imposing substantial restrictions on non-competes (and prohibiting their use altogether for employees who make less than $100,000 annually). The law is set to take effect on January 1, 2020.
Some key limitations of Washington’s new law include a presumption that any restriction lasting more than 18 months post-employment is unreasonable. However, this presumption can be overcome where an employer presents clear and convincing evidence of a legitimate need for the restriction to protect the employer’s goodwill or business interests. In addition, if the non-compete is declared void or modified by a court, an employer must pay the employee the greater of either $5,000 or his/her actual damages, plus attorneys’ fees and costs.
Washington’s new law demonstrates the aversion many courts and lawmakers have towards non-competes and sets an example for future states wishing to impose even stricter regulations on their use.
Texas Non-Compete Law
Under the Texas non-compete statute, found in Texas Business and Commerce Code § 15.50, there are two basic criteria for an employer’s covenant not to compete to be enforceable:
First, the non-compete must be ancillary to or part of an otherwise enforceable agreement when the agreement is made. This requires the employer to give consideration in exchange for the promise not to compete, usually in the form of confidential business information, employee training, or stock options. When an employee’s work requires the use of confidential information, an express promise to provide such information does not need to be included because the employer impliedly promises they will do so.
Second, the restraint of employees’ future activities must be reasonably related to protecting the employer’s business interests. Courts consider the reasonableness of restrictions’ timespan, geographic reach, and the scope of activity to be restrained. An unreasonable restriction makes the non-compete more focused on preventing future competition than protecting the employer’s business interests. However, the fact that a restriction is unreasonable does not make the non-compete unenforceable. Rather than voiding the non-compete agreement, Texas courts will reform an overbroad non-competition agreement to make it reasonable.
Since the enactment of the Texas statute, there has been considerable litigation regarding the enforceability of covenants not to compete against employees of all levels across many different industries. Below are some of the most common misconceptions about the enforceability of non-competes in Texas.
Common Misconceptions About Non-Competes
1) Non-competes are unenforceable in “right-to-work” states like Texas. FALSE
Right-to-work laws govern whether employment may be conditioned on an employee’s union membership, or lack thereof. Although a “right-to-work” may sound like it implies that all employees have a guaranteed privilege to freely seek work and be employed, this phrase is actually unrelated to non-competition laws (which allow reasonable limitations on an employee’s traditionally unrestrained mobility in our free market). Completely distinct from the enforceability of non-competes, right-to-work laws protect employees from being denied employment because they are members in a union (or because they choose not to be members or make payments to a union). Thus, the notion of employees having a “right-to-work” is strictly limited to protecting an employee’s right to participate, or choose not to participate, in a labor union or organization by prohibiting such choice from affecting the employee’s “right” to employment. Because the notion of right-to-work is completely unrelated to non-compete limitations, non-competes are still enforceable in right-to-work states like Texas.
2) Independent contractors cannot be bound by non-competes. FALSE
Although caselaw on this topic is sparse, the Texas courts faced with this issue have applied the same legal framework to analyze non-competes signed by independent contractors, meaning that if a covenant not to compete would be enforceable against a standard employee (based upon meeting the statutory requirements of being ancillary to an otherwise enforceable agreement and reasonable in time, scope and geography), it can be enforced against an independent contractor as well. However, employers who require independent contractors to sign non-competition agreements run a risk of the court concluding the independent contractor is actually an employee due to the existence of a non-compete agreement and the employer’s level of control exercised over the independent contractor, leading to possible mis-classification trouble for the employer.
3) A non-compete must expressly limit activity within a geographic area. FALSE
Although the Texas non-compete statute states that a covenant not to compete must contain reasonable limitations as to “geographical area,” some courts have concluded that a non-compete agreement lacking a geographical limitation is not per se unenforceable. Rather, if an employer reasonably restricts employees from doing business with the company’s clients, it has essentially limited the employee’s prohibited activity to the geographic area where its clients are located. Thus, lack of an explicit geographic limitation will not necessarily render a non-competition agreement invalid and unenforceable. However, many courts have found that a non-compete lacking a both a geographic restriction and a restriction on working with company clients and customers is unenforceable as written, prompting the court to revise the covenant with reasonable restrictions.
4) Nationwide geographic restrictions in non-competes are never enforceable. FALSE
Previously, the idea of a non-competition agreement that restricts an employee from working anywhere in the United States was rejected by Texas courts as overbroad and unreasonable. However, more recently, some courts have broadened this view to allow for nationwide geographic restrictions where a business is national in nature (i.e. has customers spread across the United States) and the restricted employee interacted with or had access to confidential information about the company’s customers on a national scale. So long as the restriction is also reasonably limited in scope and time and does not amount to an industry-wide exclusion, larger companies have a viable argument that a nationwide restriction is reasonable if the employee’s covered territory when working for the company spanned across all states.
5) Non-competes are unenforceable against at-will employees. FALSE
At-will employees may be terminated at any time, for any reason (absent an unlawful reason). Therefore, it is a common myth that because the employer is not making any promise to employ the employee for a set period of time, the employee cannot be held to its reciprocal promise to not to compete. However, in an at-will employment relationship, the consideration given by an employer is typically confidential company information or specialized training, not a promise of a guaranteed job term. As such, a covenant not to compete becomes enforceable once the employer performs by providing the employee with access to confidential information, specialized training, etc.
Each Dispute Is Highly Fact Dependent
The misconceptions listed above highlight some of the most common areas of confusion faced by both employees and employers regarding the enforceability of non-competition agreements in Texas. Although the courts’ developing body of statutory interpretations of the law have shed some additional light in recent years, each dispute is highly fact dependent upon the exact language contained in the non-compete, the employee’s job duties, and the employer’s business/overall industry. Therefore, it is best to consult an attorney when seeking to enforce (or avoid enforcement) of covenants not to compete.
Comparing Washington’s recent law with the Texas statute shows how treatment of non-compete agreements varies highly from state to state, highlighting the importance of understanding the laws of the state where you are living (as an employee subject to a non-competition agreement) and/or where you have company offices (as an employer utilizing non-competition agreements).
For assistance with employment and workplace disputes, contact Clouse Brown PLLC. Our attorneys are available to assist employers and business owners in solving problems dealing with trade secret disputes, covenants not to compete, and breach of fiduciary duty. We also negotiate, draft, litigate, and arbitrate employment contracts for senior-level and C-suite executives.