Foreign Plaintiff v. Foreign Defendant Destroys Diversity even if the Plaintiff’s Principal Place of Business is in Texas

The Fifth Circuit Court of Appeals started the new year with a quick civil procedure lesson, ruling yesterday in Vantage Drilling Company v. Hsin-Chi Su that lawsuits of foreign corporations with a principal place of business in Texas against foreign defendants belong in state, not federal, courts. This ruling is in line with the Second, Sixth, and Ninth Circuit Courts of Appeals, all of whom have previously held that a plaintiff’s incorporation abroad destroys diversity jurisdiction in a lawsuit against a foreign defendant, even if the plaintiff’s principal place of business is in the United States.

Plaintiff Vantage Drilling Company is an offshore drilling contractor that provides drilling units, related equipment, and work crews to major oil and natural gas companies around the world. It is incorporated in the Cayman Islands, with a principal place of business in Houston, Texas. Defendant Su, who served on Vantage’s board of directors, is a Taiwanese citizen.

After Vantage sued Su in a Texas state court for breach of fiduciary duty, fraud, and number of other business torts, Su timely removed the case to federal district court on the basis of diversity jurisdiction pursuant to 28 U.S.C. §1332(a), which states that:

(a) The district courts shall have original jurisdiction of all civil actions where the matter in controversy exceeds the sum or value of $75,000, exclusive of interest and costs, and is between

(1) citizens of different States;

(2) citizens of a State and citizens or subjects of a foreign state, except that the district courts shall not have original jurisdiction under this subsection of an action between citizens of a State and citizens or subjects of a foreign state who are lawfully admitted for permanent residence in the United States and are domiciled in the same State;

(3) citizens of different States and in which citizens or subjects of a foreign state are additional parties; and

(4) a foreign state, defined in §1603(a) of this title, as plaintiff and citizens of a State or of different States.

Vantage moved for remand arguing that its Cayman Island’s incorporation and Su’s Taiwanese citizenship destroyed diversity jurisdiction because there were aliens present on both sides of the litigation. The district court denied the motion to remand and reasoned that although Vantage had dual citizenship in the United States and Cayman Islands, it was “fully Texan” because it had no employees or operations in the Cayman Islands and its headquarters and primary operations were in Texas, where it “hire[d]local workers, [bought]local supplies, rent[ed] local buildings, donate[d] to local charities, and serve[d] local customers.” Su, on the other hand, in the district court’s opinion, was a “fully foreign party.” Analogizing to human citizens for whom “[r]emoval is proper if the dual national’s dominant nationality is American irrespective of [his/her] other affiliations,” the district court held that Vantage could not “rely[] on its foreign charter to avoid a national court despite the predominant reality of its existence.” Vantage filed an interlocutory appeal, resulting in a reversal of the district court by the Fifth Circuit.

The Court of Appeals explained that pursuant to 28 U.S.C. §1332(c)(1), a corporation is deemed a citizen of “every State and foreign state” in which it is incorporated and the “State or foreign state” where it has its principal place of business. Thus, undeniably, Vantage is a citizen of the Cayman Islands, where it is incorporated. Since Su is also a foreign citizen, the complete diversity is lacking and “there can be no diversity jurisdiction.”

Importantly, the Fifth Circuit rejected Su’s argument that the presence of bias in a state forum against a fully foreign defendant is a factor to be considered in the diversity analysis. Thus, the fact that Vantage had substantial business dealings in Texas, while Su did not, did not justify a finding of a diversity jurisdiction where both parties were foreign.

PRACTICAL IMPLICATIONS: Sometimes, incorporating a company or a subsidiary in a foreign jurisdiction makes business sense from the standpoint of taxation or corporate governance. However, a company that follows that route should keep in mind that should a dispute arise with a foreign party, the company might be forced to give up federal forum and all the advantages that come with it and litigate the case in a state court, especially if the case involves  only state law claims. In this case, as a plaintiff, Vantage preferred to be in state court, but this might not always be the case.

Leiza litigates non-compete and trade secrets lawsuits in a variety of industries in federal and state courts. For a consultation regarding a dispute involving a noncompete agreement or misappropriation of trade secrets, contact Leiza at Leiza.Dolghih@lewisbrisbois.com or (214) 722-7108 or fill out the form below.

Failure to Include a Trial Date In a Temporary Injunction Order to Enforce a Non-Competition Agreement Will Result in a Void Order

A while back I wrote a post regarding the Fifth Court of Appeals reversing a temporary injunction order because it had failed to describe specifically what trade secrets and proprietary information the company’s former employees were prohibited from releasing. Last week, the First Court of Appeals addressed another requirement for temporary injunction orders in Texas, which, if not met, renders such orders void.

The facts in Conlin, et al. v. Haun, et al., are quite prosaic.  Haun sued the Conlins for a violation of their non-compete agreements with the company in which Haun held a 51% interest. During the litigation, the parties reached an agreement regarding the temporary injunctive relief, and the Court signed an order titled “Agreed Temporary Injunction,” which enjoined the Conlins from competing with Haun’s company, and enjoined Haun from tampering with the company’s records and data. The order stated that it was effective “until the trial of this case, or further order of this Court.” The blank space, in which the trial setting date could be written, was not filled.

Several years later, the Conlins moved to dissolve the temporary injunction on several grounds, including an argument that it was void under the Texas Rule of Civil Procedure 683 because it failed to state the reasons for its issuance and set a date for trial. The trial court denied the Conlins’ motion, and they appealed.

On appeal, Haun conceded that the agreed temporary injunction order did not comply with the Rule 683, which, among other things, requires that “[e]very order granting a temporary injunction shall include an order setting the cause for trial on the merits with respect to the ultimate relief sought.”  However, he maintained that the Conlins were estopped from challenging the order because they had agreed to it.  The Court of Appeals rejected this argument and ordered that the Agreed Temporary Injunction be dissolved as void.

The Court explained that the procedural requirements of Rule 683 are “mandatory” and “an order granting a temporary injunction that does not meet them is subject to being declared void and dissolved.” Therefore, a party who agrees to a void order has agreed to nothing.

Both, the Fourth Court of Appeals in In Re Garza, 126 S.W.3d 268 (Tex. App.–San Antonio 2003, orig. proceeding) and the Fourteenth Court of Appeals in In re Corcoran,  343 S.W.3d 268, 269 (Tex. App.–Houston [14th Dist.] 2011, org. proceeding) have previously rendered similar decisions, finding that the failure of a temporary injunction order to include a specific trial setting resulted in such order being void.

CONCLUSION:  Even an agreed temporary injunction order must meet all of the requirements of Rule 683, or it will be void.  At the very least, as previously discussed, it must be specific as to what conduct or actions are prohibited, and must include a trial date. Any order that fails to meet these requirements can be reversed on appeal or dissolved by the trial court at any moment, leaving the party who applied for it, unprotected.

For more information regarding protection of trade secrets and enforcement of non-compete agreements in Texas, contact Leiza Dolghih.

The Fifth Circuit Allows Class Arbitration Waivers in Employment Agreements

Last week, the Fifth Circuit Court of Appeals joined the Ninth, Second and Eighth Circuits in holding that class arbitration waivers in employment agreements are enforceable, notwithstanding the right of employees to engage in concerted activities under the National Labor Relations Act (NLRA). The ruling has been lauded as an enormous victory for employers, even though the National Labor Relations Board (NLRB) remains free to ignore the opinion and continue to strike down class arbitration waivers.

Under the Mutual Arbitration Agreement (MAA) at issue in D.R. Horton, Inc. v. National Labor Relations Board: (1) employees waived their right to a trial in court; (2) all disputes between D.R. Horton and employees had to be resolved by final and binding arbitration; and (3) the arbitrator did “not have the authority to consolidate the claims of other employees” and did “not have the authority to fashion a proceeding as a class or collective action or to award relief to a group or class of employees in one arbitration proceeding.” The combined effect of these three provisions was that D.R.Horton’s employees could not pursue class or collective claims in an arbitral or judicial forum. Instead, their only recourse for any employment disputes was individual arbitration.

When a former D. R. Horton’s superintendent and a number of similarly situated employees attempted to initiate a nationwide class arbitration arising out of D.R.Horton’s alleged violations of overtime provisions of the Fair Labor Standards Act (FLSA), the company responded that the MAA prohibited a collective arbitration, but that the employees could proceed with individual proceedings. The superintendent then filed an unfair labor practice charge alleging that the class-action waiver violated the NLRA. The (NLRB) agreed and found that the MAA violated Section 8(a)(1) of the NLRA for two reasons. First, it required employees to waive their right to maintain joint, class, or collective employment related actions in any form. Second, the employees could reasonably interpret the language of the MAA as precluding or restricting their right to file charges with the NLRB. Last week, the Fifth Circuit rejected the Board‘s first reason, but agreed with the second.

It explained that while Section 7 of the NRLA creates a right on behalf of employees to “engage in [ ] concerted activities for the purpose of collective bargaining or other mutual aid or protection,” it does not create a substantive right to use class action procedures. In fact, the U.S. Supreme Court and several Circuit Courts of Appeals have previously recognized that there is no substantive right to class or collective procedures under the Age Discrimination and Employment Act or the FLSA. On the other hand, using Section 7 of the NRLA to invalidate an agreed waiver of a class arbitration would violate the Federal Arbitration Act (FAA), which requires that any arbitration agreement be enforced according to its terms. The Fifth Circuit found that neither NRLA’s legislative history nor its language authorized it to override the FAA. Absent an explicit language of a congressional intent to override the FAA in the NLRA, the Act’s mandate that an arbitration agreement must be enforced according to its terms – here, with a class arbitration waiver – must be followed.

Although the Fifth Circuit found that class arbitration waiver provisions do not violate the NLRA, the MAA in this case contained the following language, which did violate the statute: the employee “knowingly and voluntarily waives the right to file a lawsuit or other civil proceeding relating to Employee’s employment . . . .” (emphasis in original). Because this statement would lead employees to reasonably believe that they were prohibited from filing unfair labor practice charges with the NLRB, the Court of Appeals ordered that D.R. Horton should clarify in the agreement that employees retain access to the NLRB regardless of their agreement to arbitrate disputes.

CONCLUSION: While the Fifth Circuit’s rejection of the NLRB‘s ruling in D.R. Horton is lauded as a victory for employers, it does not guarantee that the NLRB will allow the use of class waivers in mandatory arbitration agreements. The Board regularly treats Circuit Court decisions with which it disagrees as non-binding in any other case. Thus, it may continue to reject such waivers despite the ruling.

Although the battle over class arbitration waivers in employment agreements is far from over, all employers need to review their arbitration agreements and make sure that the language used there does not convey the impression to employees that they are prohibited from filing administrative charges with the NLRB.

For more information regarding the enforcement or drafting of arbitration agreements in Texas, contact Leiza Dolghih.

Not Including a Buy Out Clause in a Medical Non-Compete Can Be Fatal to Its Enforcement

In Texas, non-compete agreements that relate to the practice of medicine must meet certain statutory requirements in addition to the consideration and reasonableness conditions discussed here.  Last week, the Fourteenth Court of Appeals in LasikPlus of Texas, P.C., et al. v. Mattioli  denied a lasic clinic’s application for a temporary injunction against a former doctor precisely because his non-compete agreement failed to comply with one of the requirements, thus allowing the doctor to proceed with the competitive practice while the parties litigated their dispute.

Pursuant to Tex. Bus. Com. Code § 15.50(b), a covenant not to compete relating to the practice of medicine is enforceable against a person licensed as a physician by the Texas Medical Board as long as such covenant:

  1. does 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. provides 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 under Section 159.008, Occupations Code;
  3. provides 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. provides 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. provides 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.

In LasikPlus of Texas, after working for the laser eye surgery center for nine years, Mattioli, a licensed ophtalmologist, terminated his employment and notified LasikPlus that he was opening his own clinic featuring laser surgical procedures less than two miles from his former clinic’s location.  LasikPlus requested a temporary restraining order (TRO) as well as a permanent injunction seeking to enjoin Mattioli from operating his clinic within the area and for the time-period prohibited by the covenant not to compete. The district court first granted an ex parte TRO, but then dissolved it after the hearing on a temporary injunction.

The Court of Appeals affirmed the district court’s decision after finding that LasikPlus had failed to prove the likelihood of success on the merits on its breach of contract claim. Since the parties conceded that the non-compete agreement did not contain a buy out clause required under Tex. Bus. & Com. Code 15.50(b), the agreement was probably not enforceable and LasikPlus would ultimately loose its breach of contract claim.  Thus, in absence of the required clause, the probability of ultimate success on the merits for LasikPlus was too low to justify a temporary injunction.

The Court of Appeals also explained that while Section 15.50(b) authorized a court to reform i.e. rewrite a buy out clause that was unreasonable, it did not authorize the court to write a buy out clause into a contract where one was absent. The Court of Appeals specifically stated that “there is no indication in Section 15.50 that the legislature intended to invest courts or arbitrators with the authority to reform noncompete covenants to create buy out provisions.  To the contrary, the section as a whole provides that if a noncompete covenant involving a physician does not have a buy out clause, it is not enforceable.” Thus, the Court rejected LasikPlus’ argument that it was likely to succeed on the merits with respect to the reformation request.

In denying the temporary injunction, the district court allowed Matiolli to compete with the clinic while the parties litigated their dispute and also determined that LasikPlus was not likely to prevail on its breach of contract claim because the non-compete agreement was not enforceable.

CONCLUSION:  In Texas, non-competition agreements that relate to the practice of medicine are subject to a specific list of requirements.  Failing to comply with these requirements will result in a non-compete agreement being unenforceable, and, therefore, completely useless.  Thus, the parties should always include a buy out clause in the agreement with an understanding that if they disagree later about the reasonableness of the clause, a court or an arbitrator can be asked to resolve their dispute.

For more information regarding the enforcement or drafting of non-competition agreements in Texas, contact Leiza Dolghih.

You Can’t Have Your Cake and Eat It Too – A Texas Court of Appeals Explains When Proceeding With Litigation Will Waive Arbitration Rights

Almost every contract now contains some sort of an arbitration clause. In fact, it is one of the first clauses an attorney looks for in an agreement when a dispute between the parties arises. This week, the Dallas Court of Appeals’s decision in Ideal Roofing, Inc., et al. v. Armbruster, et al. serves as a reminder that, at some point, proceeding with litigation of a dispute in court can result in a waiver of an applicable and otherwise enforceable arbitration clause.

In this case, Ideal Roofing and Ambrusters entered into a construction contract containing an arbitration clause. When Ambrusters’ roof started leaking, they filed a lawsuit against Ideal Roofing.  Although the defendant could have compelled arbitration almost immediately, it proceeded to litigate the case for eighteen and a half months before filing a motion to compel arbitration.  The trial court denied the motion and the Court of Appeals affirmed, providing an useful overview of the waiver standard.

In general, a party seeking to compel arbitration under the Federal Arbitration Act (FAA) must establish: (1) the existence of a valid, enforceable arbitration agreement and (2) that the claims at issue fall within that agreement’s scope. The party seeking to avoid arbitration must then establish an affirmative defense to enforcement of the otherwise valid arbitration agreement. Since Ambrusters had conceded on appeal that the arbitration agreement was enforceable, only one question remained – whether Ideal Roofing had waived its arbitration rights by participating in the litigation.

Under both federal and state law, there is a strong presumption against waiver of contractual arbitration.  A party waives its contractual arbitration rights when it “substantially invokes judicial process.” According to the Court of Appeals, a party does so when “it has taken specific and deliberate actions, after the filing of the suit, that are inconsistent with the right to arbitrate or has actively tried, but failed, to achieve a satisfactory result through litigation before turning to arbitration.”

What constitutes a “substantial” litigation conduct depends on the context, but a court must consider the following factors when deciding whether a party moving to compel arbitration has waived its contractual arbitration rights:

  • when the movant knew of the arbitration clause

  • how much discovery has been initiated and who initiated it

  • the extent to which discovery related to the merits rather than arbitrability or standing

  • how much of the discovery would be useful in arbitration

  • whether the movant sought judgment on the merits

  • whether the movant sought to compel arbitration on the “eve of the trial”

While the Court of Appeals emphasized that that delay (in moving to compel arbitration) alone does not establish waiver, in this case, the following five out of six factors supported the finding of a waiver:

  • Ideal Roofing was aware of the arbitration agreement at least four months after answering the lawsuit, but it did not move to compel arbitration until the case has been pending for 18 1/2 months and the case had been set for trial three times

  • Ideal Roofing both propounded and answered written discovery, took several expert witnesses’ depositions, and inspected the Ambrusters’ roof

  • None of the discovery conducted in this case related to arbitrability or standing

  • Ideal Roofing asserted affirmative defenses in court, filed a counter-claim, attended a two-day mediation, and filed a motion for summary judgment and set it for hearing twice

  • Ideal Roofing filed its motion to compel four months before the trial date

In addition to the burden of showing that a party seeking to compel arbitration has substantially invoked the judicial process, the party seeking to avoid arbitration must also show prejudice or “inherent unfairness in terms of delay, expense, or damage to its legal position that occurs when the party’s opponent forces it to litigate an issue and later seeks to arbitrate that same issue.” Prejudice is more easily shown when a party delays his request for arbitration and in the meantime engages in pretrial activity inconsistent with an intent to arbitrate.

The Court of Appeals found that the following evidence was sufficient to establish prejudice to Ambrusters: (1) plaintiffs’ attorney, whom they hired on contingency, would have to travel from Dallas to Houston to arbitrate; (2) plaintiffs had already paid for two days of mediation and over $3,500 in expert fees; (3) the arbitration agreement was silent as to whether discovery conducted during litigation could be used during arbitration; and (4) the Ambrusters had completed their discovery and were ready to proceed with trial when Ideal Roofing filed it motion to compel arbitration.

CONCLUSION: While answering a lawsuit and even conducting some discovery will probably not waive one’s arbitration rights, a party who is aware of an enforceable arbitration agreement, should proceed cautiously in court while it assesses whether to enforce the agreement or not and should avoid taking a position that is inconsistent with the intent to arbitrate.

For more information regarding enforcement of arbitration agreements in Texas, contact Leiza Dolghih.

A Texas Court of Appeals Weighs In On The Defensive Use of The Uniform Declaratory Judgment Act

For plaintiffs, filing a claim for breach of contract and seeking a declaratory judgment almost always go hand in hand. What happens, however, when a party threatened with such claims beats the plaintiff to the punch and files its own declaratory judgment suit on the same contract? The Fourteenth Court of Appeals has recently blessed such approach in Drexel Corp. v. Edgewood Development, Ltd., as long as certain conditions are met.

In this case, Drexel Corporation and Edgewood Development entered into a written contract in which Edgewood promised to pay Drexel a portion of the proceeds when a certain property was sold. Seventeen years later, Drexel sent Edgewood a demand letter in which it stated that the parties omitted to include in the contract a date by which the property would be sold and final payment made to Drexel. The demand letter stated that a reasonable time for the property’s sale had passed and that a reasonable estimation of Drexel’s share of the proceeds from a hypothetical sale was $1.2 million. If Edgewood did not pay $1.2 million within thirty days, Drexel would sue for “a declaratory judgment with respect to the missing term (i.e., the outside date for a sale of the property) and a monetary judgment” for Drexel’s share of the sales proceeds, plus attorneys’ fees, costs, and interest.

In response to the letter and before the 30-day deadline expired, Edgewood filed its own suit for declaratory judgment under the Uniform Declaratory Judgment Act (“UDJA”). See Tex. Civ. Prac. & Rem. Code Ann. § 37.004(a). Drexel moved to dismiss the suit for lack of subject matter jurisdiction arguing that: (1) the controversy was not ripe since Edgewood did not plead or prove that it would suffer any imminent injury or harm without the judicial declaration; and (2) the UDJA should not be used “to deprive the real plaintiff of the traditional right to choose the time and place of suit.” The Court of Appeals affirmed the trial court’s subject-matter jurisdiction rejecting both arguments.

Requirement No. 1: Justiciable Controversy

Under the UDJA, a person interested under a written contract or whose rights are affected by it “may have determined any question of construction or validity arising under the . . . contract.” Tex. Civ. Prac. & Rem. Code Ann. § 37.004(a). A court may construe the contract “either before or after there has been a breach.” Id. § 37.004(b). According to the Court of Appeals, a declaratory judgment under the UDJA is appropriate only if “a justiciable controversy exists as to the rights and status of the parties and the controversy will be resolved by the declaration sought,” and the Act cannot be used to resolve a hypothetical or contingent situation. Since Drexel asserted in the demand letter that Edgewood was obligated to pay $1.2 million under the contract and Edgewood denied that obligation, there was a justiciable controversy between the parties.

Requirement No. 2: Ripeness

In addition to the justiciable controversy requirement, the parties’ dispute must be ripe for adjudication. To evaluate the ripeness of a claim, courts will consider “whether, at the time a lawsuit is filed, the facts are sufficiently developed ‘so that an injury has occurred or is likely to occur, rather than being contingent or remote.’” The threat of harm “can constitute a concrete injury, but [it] must be ‘direct and immediate’ rather than conjectural, hypothetical, or remote. To show that such injuries are likely to occur, for example, parties must demonstrate that the harm is imminent, but has not yet impacted them.” Pursuant to this standard, because Drexel made a demand for payment under the contract, the declaratory judgment by Edgewood called not for an advisory opinion upon a hypothetical basis, but for an adjudication of its rights and obligations under the parties’ agreement, making the parties’ dispute ripe for adjudication.

Thus, as long as a party can establish the above requirements, it can seek a declaration of contractual non-liability in response to a demand made under a contract by another party.  The Court of Appeals specifically rejected Drexel’s argument that Edgewood’s filing of a declaratory judgment lawsuit deprived the “real” plaintiff of its “traditional right to choose the time and place of suit.”  It explained that while this principle might apply to tort claims, it has no application in a contractual dispute because “only a plaintiff may seek redress for a tort. But in a contract case, either party may breach the agreement and either party may sue for a breach or a judicial determination of rights under the contract.” Thus, since both parties might have suffered damages in a contract situation, there is no “real” plaintiff.

PRACTICAL IMPLICATIONS:  When considering how to respond to a demand under a contract, a potential defendant should consider the pros and cons of filing its own declaratory judgment suit instead of waiting for the plaintiff to act on its threat.  Filing such a suit can create a certain strategic advantage since it allows the party to pick the court and the venue for filing, control the posture of the suit, and frame the facts and issues for the court.

On the other side, unless a potential plaintiff thinks that the demand letter will succeed in persuading the other party to fulfill its contractual obligations, it might want to hold off on making the presentment under Tex. Civ. Prac. & Rem. Code § 38.002 until after it files the suit so as to not tip off the other side and allow it time to file its own suit under the UDJA.

For more information regarding contract disputes in Texas, contact Leiza Dolghih.

In Texas, a Court Can Rewrite Your Non-Compete For You, But It Might Cost You a Pretty Penny

Texas courts have the authority to rewrite non-compete agreements that they find to be unreasonable. Thus, a business might be tempted to draft a broad non-compete agreement thinking that when a push comes to shove, it can just ask the court to reform the agreement to make it more reasonable.  However, the recent First Court of Appeals’ decision in Sentinel Integrity Solutions, Inc. v. Mistras Group, Inc., et al.illustrates why relying on reformation as a way of fixing an overly-broad non-compete agreement could end up being very costly to the employer.

At issue in this case was a non-compete agreement signed by Sentinel’s employee, Olson, upon his promotion within the company. The agreement required that he “refrain from competing with [Sentinel] or otherwise engaging in ‘Restricted Activities'” for a period of 3 years after the termination date within a region including 7 cities and 4 counties in Texas, locations in 6 states and 1 country, and  “a twenty (20) mile radius around all customers’ job sites and/or project facilities that [the employee] called on or services on behalf of [Sentinel] in all geographic regions, wherever located.”  Olson only worked at the Sentinel’s Corpus Christi location.

When Olson left to work for another company, Sentinel immediately sued him and his new employer seeking enforcement of the non-compete agreement under Tex. Bus. & Com. Code Ann. 15.50(a) and, alternatively, reformation of the agreement under Tex. Bus. & Com. Code Ann. 15.51(c) if the court found that the covenant was not reasonably limited as to time, geographic area, or scope of activity.

Until the last day of trial, Sentinel maintained that the covenant not to compete was enforceable as written. On the last day, its counsel conceded on the record that the agreement was unreasonable at least as to the geographic area it covered. Still, Sentinel did not request reformation until after the jury returned its verdict requiring it to pay Olson’s $750,000 attorney’s fees. The trial court reformed the non-compete agreement as requested by Sentinel, but also adopted the jury’s award of the attorney’s fees.

The award was based on Tex. Bus. & Com. Code Ann. 15.51(c), which allows a trial court to award an employee against whom a non-compete is being enforced his attorneys fees if the employee proves that:

  • plaintiff knew at the time the employment agreement was executed that the covenant did not contain limitations as to time, geographical area, and scope of activity to be restrained that were reasonable and the limitations imposed a greater restraint than necessary to protect [plaintiff’s] goodwill or other business interest, and
  • plaintiff sought to enforce the covenant to a greater extent than was necessary to protect its goodwill or other business interest.

Sentinel argued on appeal that there was not enough evidence to support the findings under Section 15.51(c), but the Court of Appeals disagreed based on the following:

  • Sentinel’s manager testified that he purposefully made the geographical area covered by the non-compete provision broad “to cover pretty much all of the general areas that we think or anticipate would be covered” and he relied on a provision allowing a trial court to reform the agreement if necessary;
  • The covenant not to compete expressly stated that “Employee and Company agree that the limitations as to time  and scope of activity to be restrained are reasonable,” but it was silent on the reasonableness of the geographic area;
  • Sentinel’s manager sent an email to Olson prior to his signing of the non-compete agreement assuring him that the agreement would not prevent Olson from working as an inspector;
  • Sentinel attempted to enforce the covenant’s ban on competition in “in any capacity” that overlapped with managerial duties at Sentinel, i.e. “inspector, manager, supervisor, dishwasher, it doesn’t matter”;
  • Sentinel attempted to enforce the covenant’s general ban on “competing,” including restricting Olson from working in geographic areas that were not tailored to Olson’s work on behalf of Sentinel or even to Sentinel’s own current business.

CONCLUSION:  Sure, you can always ask a Texas court to reform a non-compete agreement, and the court will most likely do so.  However, if it finds that a company knew at the time the non-compete agreement was executed that it contained unreasonable restrictions and it tried to enforce it to a greater extent than was necessary to protect its business interest, the company might end up paying the other side’s hefty attorney’s fees bill on top of the reformation.

Thus, instead of handing employees a boiler-plate broad non-compete agreement with a hope that a court can later “fix” it if necessary, a business should attempt to draft its non-compete agreements to reflect the particular geographic areas and the job duties of the employees that sign them.

While it is not always possible to know where an employee will end up working over the years, a language in a non-compete agreement that ties the “restricted area” of competition to the area where the employee is going to work, without naming specific geographic locations, plus a reasonable mile radius, can help a company avoid a Section 15.51(c) award.

Similarly, instead of including every possible activity in a list of competitive activities to be restrained, catering the language to the job description of the employee who will be signing the agreement, might help ward off a Section 15.51(c) award.

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.

Practical Guide to Enforcing Non-Compete Agreements in Texas (Part II)

If you have followed the steps in Part I, you might now be in possession of evidence confirming that your ex-employee is violating his or her non-compete agreement. Such evidence will do you no good, however, if the non-compete agreement that you are relying upon is not enforceable. So, before you race to the courthouse asking for a temporary injunction, an assessment of enforceability is in order. This analysis needs to be done quickly, if not simultaneously, with the steps described in Part I.

Over the years, Texas courts have steadily moved toward making the enforceability of non-compete agreements easier. This post addresses the most current general requirements as spelled out by the Texas Supreme Court over the last decade, but beware of the old cases that used to impose additional requirements, but are no longer good law.

In Texas, non-competition agreements are governed by Section 15.50(a) of the Texas Business & Commerce Code, which states 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 to the extent that it contains 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.”

Thus, Texas courts require two factors to enforce a non-compete agreement that is ancillary to an otherwise enforceable agreement:

1. There must be consideration.

2. The limitations on time, geographical area, and scope of activity to be restrained must be reasonable.

Question 1: Did the Employee Receive Adequate Consideration for His/Her Promise Not to Compete?

Because Texas is an at will employment state, an employer’s offer of employment can be terminated at any time, is illusory, and does not by itself constitute sufficient consideration for an employee’s promise not to compete. Therefore, an employer must promise its employees something other than an offer of employment in exchange for their signature on the non-compete, which includes confidential information, trade secrets or specialized training provided by the employer. Consideration can also include stock options or other financial incentives that are “reasonably related” to the employer’s interest that is worthy of protection.

Question 2: Are the Limitations on Time, Geography and Scope Imposed by the Non-Competition Agreement Reasonable?

Non-competition agreement must restrain no more activity than is necessary to protect the legitimate business interest of the employer. Texas courts have consistently refused to enforce agreements that prohibit all competitive activity or prohibit employment in any capacity for a competitive entity. The courts have also refused to enforce agreements that prohibit activity unrelated to the work the employee preformed for the former employer.

Similarly, Texas courts have also determined that non-competition agreements that contain no geographical limitations or fail to limit the scope of activity to be restrained are unreasonable and unenforceable. Generally, a reasonable area of restraint consists of only the territory in which the employee worked for the former employer.  Thus, courts in the past have refused to enforce non-competition agreements with nationwide applicability when the employee did not have nationwide responsibilities for the former employer.

While the court in Texas have authority to reform a non-competition agreement to narrow the scope or the geographical area of the agreement so as to make it enforceable, they will not always do so.

So, hopefully, you had legal advice regarding the non-compete agreements when they were drafted and the above issues are not going to prevent you from enforcing them. If not, you need to revise your current non-compete agreements and the employment policies that affect the exchange of consideration to ensure that the above-described requirements are met.

If, after conducting the above enforceability analysis, you believe that your non-compete agreements contain reasonable limitations and the former employee was given some sort of consideration in exchange for signing the non-compete agreement, you might have an enforceable agreement on your hands. I will discuss the next steps of enforcing a non-compete agreement in Part III.

Leiza Dolghih is a partner at Lewis Brisbois Bisgaard & Smith LLP in Dallas, Texas and a Co-Chair of the firm’s Trade Secrets and Non-Compete Disputes national practice.  His practice includes commercial, intellectual property and employment litigation.  You can contact her directly at Leiza.Dolghih@LewisBrisbois.com or (214) 722-7108.

The Fifth Circuit Triples an Overtime Payment Award; Says the Fluctuating Workweek Method Was Not Warranted in a FLSA Misclassification Case

Last Friday, the Fifth Circuit in Black v. SettlePou, PC ruled that the Northern District of Texas erred in applying the Fluctuating Workweek (FWW) method of calculating an overtime payment award where there was no evidence that the employee had agreed to the flexible work hours. The Court of Appeals remanded the case and ordered a recalculation of damages using 1 1/2 times the regular hourly rate of pay instead of 1/2 under the FWW, which would result in a tripling of the actual and liquidated damages.

Black was employed as a legal secretary and paralegal at SettlePou, P.C. from 2005–2010. She was first hired as a non-exempt legal secretary, then promoted to a paralegal, but remained a non-exempt employee, as defined by the Fair Labor Standards Act, 29 U.S.C. §§ 201–19 (FLSA), earning overtime at 1 1/2 regular rate of pay. In 2007, SettlePou informed Black that she was to begin supervising one of their legal secretaries, therefore, she would be reclassified as exempt, making her ineligible for overtime pay as an exempt employee. Immediately following her reclassification Black complained both verbally and in writing to her supervisor and to the human resources department stating that she thought she should be paid overtime for her extra hours worked.  After she was terminated in 2010, she filed a suit against SettlePou on behalf of herself and all other similarly situated paralegals for violations of the FLSA.

The jury found that SettlePou had willfully violated the FLSA by misclassifying Black as exempt and the she was owed 274 hours of overtime pay. Apparently, when Black was promoted to a supervisor position, she was told that she would be given supervisory authority, but was never actually given one.  Thus, she continued to perform the same duties, but was now ineligible for overtime.

The district judge calculated the amount of overtime premium due to Black by multiplying her 274 overtime hours by one-half of her hourly pay rate.  Black filed a motion to alter or amend the judgment, arguing that the district court should have used 1 1/2 times the regular hourly rate of pay instead of 1/2 in its calculation of damages, but the district court denied the motion.

In overruling the district court, the Fifth Circuit explained that “[t]he FWW method of calculating overtime premiums in a misclassification case is appropriate when the employer and the employee have agreed that the employee will be paid a fixed weekly wage to work fluctuating hours,” and that the existence of such agreement is a question of fact.  The record evidence in this case – both the parties’ initial understanding and their course of conduct – showed that there was no such agreement between Black and her employer because:

  • SettlePou’s Human Resources Director testified that she was unaware of any fluctuating workweek agreement with Black
  • Black testified that her understanding was that she would be compensated with a fixed weekly wage for working a regular schedule of 37 1/2 hours
  • the payroll records showed that Black was being compensated for full time employment, which was defined in the Employee Handbook as 37 1/2 hours per week
  • the Employee Handbook only stated that exempt employees would not be compensated for overtime, but did not explain that the full-time paralegals like Black were expected to work a fluctuating work week or overtime

The critical issue in this case, was “not only whether SettlePou paid Black a fixed salary for varying hours, but whether SettlePou and Black had agreed that a fixed salary would compensate her for all of the hours she worked each week.” The fact that Black complained to the Human Resources Director and her supervisor about having to work overtime without receiving overtime payment, showed that she did not agree to compensation based on the fluctuating work week.

MORAL OF THE STORY:  First, make sure your employees are classified correctly as exempt or non-exempt.  Second, if you expect employees to work flexible hours, make sure that they are made aware of that, preferably in writing, and that the compensation system reflects this arrangement. It won’t hurt to have employees sign a statement acknowledging that they are expected to work fluctuating hours.  Third, make sure that your employee handbooks, employment applications, payroll records, and other paperwork associated with the fluctuating work week positions reflect the specific nature of that arrangement. Finally, make sure that the human resources department is knowledgeable about any fluctuating work week positions.

Leiza Dolghih is a partner at Lewis Brisbois Bisgaard & Smith LLP in Dallas, Texas and a Co-Chair of the firm’s Trade Secrets and Non-Compete Disputes national practice.  His practice includes commercial, intellectual property and employment litigation.  You can contact her directly at Leiza.Dolghih@LewisBrisbois.com or (214) 722-7108.

The ADA Does Not Require a Nexus Between a Requested Accommodation and an Essential Job Function – Says the Fifth Circuit

The Fifth Circuit Court of Appeals recently ruled in Feist v. State of Louisiana, that a “reasonable accommodation” under the Americans with Disabilities Act (ADA), does not need to “relate to the performance of essential job functions.” In reversing the district court, the Court of Appeals held that an accommodation could be reasonable even if it does not relate to the essential job functions as long as it makes the workplace “readily accessible to and usable” by a disabled employee, or, alternatively, it allows an employee with a disability to “enjoy equal benefits and privileges of employment as are enjoyed by [the employer’s] other similarly situated employees without disabilities.” Thus, the district court erred by requiring a nexus between the employee’s requested accommodation, a reserved parking space, and her job functions as an assistant attorney general.

The ADA prohibits covered employers from “discriminat[ing] against a qualified individual on the basis of disability.” 42 U.S.C. § 12112(a). Discrimination includes failure to make “reasonable accommodations to the known physical or mental limitations of an otherwise qualified individual with a disability . . . unless such covered entity can demonstrate that the accommodation would impose an undue hardship.” 42 U.S.C. § 12112(b)(5)(A). According to the Fifth Circuit Court of Appeals, a plaintiff asserting a discrimination claim under the ADA, must show the following:

  • s/he is a “qualified individual with a disability;”
  • the disability and its consequential limitations were “known” by the covered employer; and
  • the employer failed to make “reasonable accommodations” for such known limitations.

The district court in Feist held that the plaintiff established the first two elements, but failed to show that the requested accommodation was “reasonable” because she had failed to demonstrate that not having a reserved parking spot limited her ability to perform “the essential functions of her job” as an assistant attorney general. The Court of Appeals, however, ruled that “the ADA, and all available interpretive authority” indicated that “reasonable accommodations” were not restricted to modifications that enabled performance of essential job functions.

Under the ADA, a reasonable accommodation may include:

(A) making existing facilities used by employees readily accessible to and usable by individuals with disabilities; and

(B) job restructuring, part-time or modified work schedules, reassignment to a vacant position, acquisition or modification of equipment or devices, appropriate adjustment or modifications of examinations, training materials or policies, the provision of qualified readers or interpreters, and other similar accommodations for individuals with disabilities. 42 U.S.C. § 12111(9)(A).

Moreover, the ADA implementing regulations define “reasonable accommodation” as follows:

(i) Modifications or adjustments to a job application process that enable a qualified applicant with a disability to be considered for the position such qualified applicant desires; or

(ii) Modifications or adjustments to the work environment . . . that enable an individual with a disability who is qualified to perform the essential functions of that position; or

(iii) Modifications or adjustments that enable a covered entity’s employee with a disability to enjoy equal benefits and privileges of employment as are enjoyed by its other similarly situated employees without disabilities. 29 C.F.R. § 1630.2(o)(1) (emphasis added).

Thus, the Court of Appeals concluded that a modification that enables an individual to perform the essential function of a position is only one of three categories of reasonable accommodation.

What does this mean for Texas business owners? When addressing an accommodation request by an employee with a disability, the employer should not deny the request simply because the accommodation does not relate to the employee’s essential job functions.  The employer should further consider whether the accommodation will allow the employee to enjoy the same benefits and privileges that other similarly situated employees without disabilities enjoy.  If the answer to that question is “yes,” then the employer will have to provide the accommodation, unless it creates an undue hardship.

Leiza Dolghih is a partner at Lewis Brisbois Bisgaard & Smith LLP in Dallas, Texas and a Co-Chair of the firm’s Trade Secrets and Non-Compete Disputes national practice.  His practice includes commercial, intellectual property and employment litigation.  You can contact her directly at Leiza.Dolghih@LewisBrisbois.com or (214) 722-7108.