Forfeiture Provisions in Executive Stock Incentive Programs Are Not Covenants Not to Compete

The Texas Supreme Court in ExxonMobil Corp. v. Drennen held that forfeiture provisions in non-contributory profit-sharing plans are not covenants not to compete, but stopped short of opining on whether they constitute an unreasonable restraint of trade in violation of Tex. Bus. Code 15.05.

In Drennen, ExxonMobil’s engineer and Exploration Vice President of Americas, was awarded restricted stock options through the company’s incentive program, which allowed the company to terminate Drennen’s outstanding awards if (among other conditions) he engaged in activities “detrimental” to the company, including working for ExxonMobil’s competitors.

Drennen retired from ExxonMobil in 2007, after working there for 31 years. At the time of his retirement, he had 73,900 shares (approximately $6.2 million) of stock through the company’s incentive program.  When he went to work for a competitor shortly after his retirement, ExxonMobil notified him that his incentive awards were cancelled. Drennen filed a declaratory action seeking a declaration from the district court that the “detrimental activity” forfeiture provision in ExxonMobil’s incentive program was an unenforceable covenant not to compete under Texas law because it did not contain geographic, time, or scope limitations.

Although the incentive program stated that it was governed by New York law, the Court of Appeals decided that Texas had a materially greater interest and a strong public policy interest in the dispute involving the enforceability of a covenant not to compete used against Texas employees, and, therefore, applied Texas law in ruling that the forfeiture provision was unenforceable under Section 15.50 because it did not contain reasonable time, scope, and geographical limitations.  The Texas Supreme Court  disagreed, ruling that New York law governed the forfeiture provision, but even if Texas law applied, the forfeiture provision used by ExxonMobil was not a covenant not to compete subject to Section 15.50 requirements.

The Supreme Court explained that covenants not to compete are generally defined as “covenants that place limits on former employees’ professional mobility or restrict their solicitation of the former employers’ customers and employees.”  Such covenants are governed by the Texas Covenants Not to Compete Act (TCNCA) and, pursuant to it, must be: (1) ancillary to or part of an otherwise enforceable agreement at the time the agreement is made; and (2) contain limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee.

The forfeiture of stock provision contained in ExxonMobil’s incentive program, however, did “not fit the mold” of covenants not to compete because it did not limit Drennen’s professional mobility or restrict his future employment opportunities. Instead, according to the Court, the provision simply rewarded Drennen and other employees for continued employment and loyalty to ExxonMobil. Unlike a non-compete, where employer would have to bring a breach of contract suit to enforce the clause, the forfeiture provision simply allowed the employer to stop the incentive program, which belonged to the employer in the first place. Thus, forcing an employee to chose between competing with the former employer without restraint from the former employer and accepting benefits of the retirement plan to which the employee contributed nothing, does not create a covenant not to compete.

The Court concluded this part of the analysis as follows:

Whatever it may mean to be a covenant not to compete under Texas law, forfeiture clauses in non-contributory profit-sharing plans, like the detrimental-activity provisions in ExxonMobil’s Incentive Programs, clearly are not covenants not to compete.  . . . Whether such provisions . . . are unreasonable restraints of trade under Texas law, such that they are unenforceable, is a separate question and one which we reserve for another day.

CONCLUSION:  Because the Texas Supreme Court ruled that forfeiture provisions of that type used by ExxonMobil are not covenants not to compete, they do not have to comply with the requirements of TCNCA, i.e. such forfeiture provisions do not have to be “ancillary to an otherwise enforceable agreement” or be limited in scope, time or geographical reach. The question remains whether such forfeiture provisions constitute an unreasonable restraint of trade under the Section 15.05 of the Texas Free Enterprise and Antitrust Act of 1983, which states that “every contract, combination, or conspiracy in restraint of trade or commerce is unlawful.”  However, the Court’s decision took away an easy way for employees to fight the forfeiture provisions by pointing to the fact that they don’t contain limitations.

In light of this opinion, employers should take a close look at ExxonMobil’s incentive plan and determine whether their own programs have the same characteristics, and employees with significant stock option or profit sharing arrangements as part of the compensation package should carefully review the forfeiture provisions before agreeing to them and, where possible, negotiate their reach.

Leiza litigates non-compete and trade secrets lawsuits on behalf of EMPLOYERS and EMPLOYEES in a variety of industries, and knows how such disputes typically play out for both parties. If you need advice regarding your non-compete agreement, contact Ms. Dolghih for a confidential consultation at Leiza.Dolghih@GodwinLewis.com or (214) 939-4458.

2 Comments on “Forfeiture Provisions in Executive Stock Incentive Programs Are Not Covenants Not to Compete

  1. Pingback: Is Your Non-Compete Agreement Hidden in Your Stock Option Plan? | North Texas Legal News

  2. Pingback: Non Compete Law in Texas: 2014 in Review | North Texas Legal News

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