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Noncompete pacts in Texas: New ruling brings clarity … and questions

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in Employee Benefits Program,Employment Law,Hiring,Human Resources

by Scott A. Brutocao, Ogletree Deakins, Austin

Last October, the Texas Supreme Court ruled employers may require new and existing employees to sign covenants not to compete, even if they are “at will” employees. As long as the employees get something in return for agreeing to the restrictions their employers want, the agreements are legal.

The conventional thinking among the courts about noncompete covenants is shaped by the following logic:

  1. Covenants not to compete depend on the employers providing employees the kind of confidential information about clients, markets, business processes and so forth that an employee might need to be effective on the job—and that the employee could use after leaving the employer.
  2. Such confidential information benefits employees. The employer provides it as “the something in return” for the employee’s promise not to compete.

Before the Texas Supreme Court ruled, a contract-law technicality put into question the validity of noncompete covenants for at-will employees: Because Texas employment is at-will, an employer had the right to fire an employee at any time. Thus, it could fire the employee before giving the confidential information.

In other words, the employer’s promise to provide confidential information could be an empty promise. If the employee got nothing in exchange for his promise not to compete, a court might conclude there was no contract at all.

Promise to provide info suffices

The state Supreme Court laid that issue to rest, ruling that the employer could indeed merely promise to provide confidential information in return for an employee’s agreement not to compete following termination of employment. The fact that no confidential information is exchanged when the covenant is actually signed is no longer an issue that would void the covenant.

However, at some point in the employment relationship, the employer must actually provide confidential information to the employee. If the employer fails to deliver the confidential information, the “consideration” for the noncompete covenant would fail and the employee would be free to compete against the employer following separation.

The state Supreme Court then told the trial courts to carefully analyze whether the business interests of the employer justified the scope of the covenant not to compete. Thus, courts must make sure that the confidential information provided by the employer justifies the extent of the restraint on the employee’s post-employment conduct. Although this is not a new concept in the law of covenants not to compete, it is expected to take on greater emphasis in future litigation.

More litigation?

Employers should expect more lawsuits over covenants not to compete. For employers who want to stop former employees from competing in violation of an agreement, the decision provides a powerful basis in which to justify a lawsuit.

Most likely, the lawsuit will not be thrown out on technical grounds. For this reason, cease-and-desist letters will be most effective, as well as other techniques designed to prevent competitive activity. Moreover, many executives will think twice before leaving their jobs if they have signed a properly drafted noncompete covenant and received confidential information from their employer.

Employers should pay attention to noncompete issues during the hiring process. Ask applicants if they have signed a noncompete agreement. Such agreements are more likely to be enforceable now, so hiring employers should diligently investigate:

  • The extent of any covenants.
  • The extent to which their business competes with previous employers.
  • Business interests of previous employers in restraining employee activity.

Because the courts are going to ask whether an employer had a legitimate need for their employees to sign noncompete covenants, each case will be judged on its own merits. 

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Scott Brutocao is a shareholder in the Austin office of Ogletree Deakins and represents employers in all aspects of labor and employment law, including litigation and counseling. Mr. Brutocao is board certified in labor and employment law by the Texas Board of Legal Specialization.  

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