A Texas Court Refuses to Enforce a Non-Compete Agreement In a Case Involving Every Employer’s Worst Nightmare

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Last week, a federal court in Texas refused to enforce a company’s non-compete agreement against four key employees who started a competing business because the agreement was missing a key term – the end date.  The company argued that the court could rewrite the non-compete to add a reasonable end date (a procedure sometimes allowed in Texas) but the court refused to do it holding that it could not fix an unenforceable agreement. Thus, the four employees who started a competing business remain free to compete and solicit the company’s clients. 

The company argued that while the employees worked there, they, collectively, were exposed to all kinds of confidential information, including company-wide strategic plans, OEM relationships and pricing levels, details of written and oral contracts with customers, manuals, forms, techniques, methods and procedures at the company,  the Salesforce database that contained a list of all company customer contacts and point persons within the customer, as well as specific notes from customer visits and discussion points, cost of materials, and the company’s product margins.   The company also told the court that it allowed the departed employees to entertain customers and reimbursed them for expenses, and paid for their cell phones used to communicate with such customers.  

Nevertheless, because there was no evidence that the employees took any confidential information with them when they left and because the company admitted that its product manufacturers and customer information were not confidential, the company could not stop the employees from competing once the court declared the non-compete agreement not enforceable. 

BOTTOM LINE: The above situation can be avoided through simple practice of: (1) knowing what is in the company non-compete agreements; (2) making sure all the key provisions required by the relevant statutes are included; and (3) periodically updating non-compete agreements so that they are compliant with the relevant state law.   

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.  Her practice includes commercial, intellectual property and employment litigation.  You can contact her directly at Leiza.Dolghih@LewisBrisbois.com or (214) 722-7108.

 

What is a “Reasonable” Non-Competition Agreement?

Most states will enforce reasonable non-competition agreements, but what is “reasonable” and how the courts reach that conclusion varies.  In Texas, there are some rules of thumb as to what is generally considered reasonable.  A recent opinion from a federal court in Austin illustrates these rules as well as what happens when an employer attempts to enforce an overbroad, i.e., “unreasonable” non-competition agreement. 

In this case, a company that provides management services to amenity facilities, spas, and health clubs, sued its former employees for breaching their non-compete agreements after they went to work for a competitor.  Among many claims that the company brought in the lawsuit, it specifically asked the Court to enforce the non-compete agreements and enjoin (i.e. prevent) the former employees from competing with it for 12 months. 

The employees’ non-compete agreements prohibited them from being “employed in a business substantially similar to or competitive with” the company for a year after leaving its employment.  The agreements were not limited in their geographic scope or in the scope of activities to which they applied.  The court stated that the company prohibited its former employees from working for its competitors anywhere in the country, even if a competitor was based outside the geographic area where the employees worked.  It also barred the employees from working for a competitor “in any capacity” and, therefore, was not related to the employees’ duties while they worked for the company. 

The court explained that in Texas, “the hallmark of enforcement [of non-compete agreement] is whether or not the covenant is reasonable.”  Generally, a reasonable area for purposes of a covenant not to compete is considered to be the territory in which the employee worked. Furthermore, noncompete agreements barring an employee from working for a competitor in any capacity are invalid.  To be valid, the restrictions on the scope of the employee’s activities at a new company have to bear some relation to the activities of the employee at the old company.  In the case above, the court specifically noted that the company failed to “articulate how [its] broad non-compete agreements [were] necessary to protect its business interests,” which is another requirement for an enforceable non-compete agreement in Texas. 

The company in this case will get another chance to address the above issues and produce some evidence supporting the reasonableness of its restraints at the temporary injunction hearing in a few weeks. However, the court’s denial of the company’s request for a temporary restraining order means that the employees in question remain free to continue to work for the company’s competitor until the hearing. 

BOTTOM LINE:  When it comes to non-compete agreements, “reasonableness” is the name of the game, and while employers often want to err on the side of safety and put in longer and larger restrictions thatn what might be necessary, doing so can backfire when an employer has to enforce its agreement in court. Setting non-compete restrictions should not be done off-the-cuff, but should be a strategic and well-thought-out decision supported by legitimate business reasons. 

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 Her practice includes commercial, intellectual property and employment litigation.  You can contact her directly at Leiza.Dolghih@LewisBrisbois.com or (214) 722-7108 or fill out the form below. 

 

 

A Famous Dallas Chef Defeats an Injunction Based on “Unclean Hands” Defense, Can Now Use His Name

Foodie or not, if you live in Dallas, you have probably been to one of Kent Rathbun’s restaurants.  And if you read Dallas Observer, you have probably read about Rathbun’s ongoing legal battle with a former business partner, which involves the right to use Rathbun’s name and likeness in the restaurant industry.  If not, this D Magazine article can you fill you in on why Rathbun’s name is a big deal, and this Dallas Observer article can catch you up on the acrimonious relationship and the arising legal woes. 

While the case is ongoing, this past Friday, the Dallas Court of Appeals issued a ruling in Rathbun’s favor on the basis of the “unclean hands” defense, which is often alleged, but rarely supported, in non-competition disputes.  

By way of background, back in 2009, Rathbun assigned the rights to his name and likeness to an entity he co-owned with his then-business partner. After they parted ways, Rathubun filed a lawsuit seeking a declaration from the Court that the assignment was a “covenant not to compete” and was unenforceable because it failed to comply with the requirements of the Texas Covenants Not to Compete Act (see my previous post on the requirements here). 

In response, the former partner sought an injunction from the Court prohibiting Rathbun from using his name or likeness while the parties litigated their dispute based on the assignment agreement. During the temporary injunction hearing, Rathbun introduced (1) deposition testimony of his former business partner regarding his knowledge of Rathbun’s lack of business sophistication and his fiduciary duties owed to Rathbun and (2) deposition testimony that the company to which Rathbun assigned the rights to his name might have assumed some liabilities without full disclosure to Rathbun, even though he was a part-owner at that time.

The trial court denied the injunction, allowing Rathbun to keep using his name as long as he did not disparage his former partner, and the Dallas Court of Appeals upheld the denial. While it refused to consider whether the assignment agreement was a “covenant not to compete” covered by the Texas Covenants Not to Compete Act, it did find that the deposition testimony described above presented sufficient evidence to support the “unclean hands” defense asserted by Rathbun. 

The unclean hands defense “allows a court to decline to grant equitable relief, such as an injunction, to a party whose conduct in connection with the same matter or transaction has been unconscientious, unjust, or marked by a want of good faith, or one who has violated the principles of equity and righteous dealing.”  Here, the Court found that there was some evidence that the company that was now trying to enforce the assignment acted inequitably when it failed to fully disclose to Rathbun that it had assumed certain liabilities, which burdened him as a part-owner of the company.  Consequently, its unclean hands prevented it from obtaining an injunction against Rathbun.

BOTTOM LINE: While the Court of Appeals’ ruling in this case is not a final decision on the merits of this defense and can still be appealed to the Texas Supreme Court, it does provide a glimpse into what type of behavior by a party who seeks an injunction may rise to the level of “unclean hands” such that the party is prevented from getting injunctive relief. 

Companies should be aware that when they seeks to enforce a non-compete agreement, their own behavior can often be scrutinized for any signs of unfair or bad faith conduct that may be used to deny the injunctive relief.

Leiza litigates non-compete and trade secrets lawsuits in a variety of industries. If you are a party to a dispute involving a noncompete agreement in Texas, contact Leiza at Leiza.Dolghih@lewisbrisbois.com or (214) 722-7108 or fill out the form below.

What Should a Company do When it Suspects That an Employee Stole Its Trade Secrets?

preciousEmployees take their employers’ trade secrets all the time. It’s a fact of life.  No matter what systems an employer has in place, sooner or later a key employee will depart and take some trade secret information, data, or documents with them. Most employees take trade secrets because that information will help them land a better job or open a competing business. Some take it because they believe that the information belongs to them since they worked on it or created it. Whatever their reasons may be, the loss of competitive advantage resulting from the disclosure of trade secrets to competitors or release of that information in the open market may cause significant, and often irreparable, damage to the former employer.

So, what should a company do if it suspects trade secrets theft by a former employee?

First, the company should identify and collect all of the employee’s electronic devices in its possession – desktop computers, laptops, tablets, company-issued phones, and any other devices that the employee used during his work and that may contain company information.

Second, the company should have a qualified forensic examiner image the devices to preserve the relevant electronic evidence that may show whether the employee used any of these devices to copy or transfer the trade secret information and then search such devices for relevant evidence.  This should be done pursuant to a protocol devised by the examiner and a legal counsel to ensure that the evidence will later hold up in court.

Third, the company should search the employee’s emails for any evidence of trade secrets transfer.

Fourth, the company should interview its employees and/or third parties who may have relevant information.

** The company must move quickly and have an attorney supervise and coordinate the above efforts to make sure the collected evidence can later be used in court (i.e. is admissible) and to make sure the relevant communications are protected by the attorney-client privilege.

Fifth, if the company discovers evidence of trade secrets theft, it should file a lawsuit and seek a temporary injunction – a court order – prohibiting the former employee and anybody else acting on his/her behalf from using or disclosing the company’s trade secrets.  While this may be costly, this is the only effective way to stop the employee before he or she uses or discloses the trade secrets or does significant damage to the company.

Here is a real-life example where the above steps worked and helped a company stop a former employee from opening a competing business using the company’s trade secrets. 

Earlier this year, I wrote about a case that involved a Texas employer who followed the above steps and was able to obtain a temporary injunction and then a permanent injunction shutting down a competing business that a former employee opened using the gym’s trade secrets.  In that case, a Houston gym filed a lawsuit against its former regional vice president and his wife claiming that they took the gym’s confidential information and opened their own competing gym and medspa.  The gym obtained a temporary injunction against the former employee and his new company within four days of filing the lawsuit because it had emails and other electronic evidence establishing the trade secrets copying and transfer by the VP.

Just recently, the court in that case issued a permanent injunction prohibiting the former VP from opening or operating any new locations of his gym and medspa through September 2017 and from opening any gyms within a seven-mile radius of any of Life Time’s 123 existing locations, as well as employing or attempting to employ any current or former Life Time employees.

Additionally, within 20 days of the court order, the VP and his wife were required to return or destroy all of the gym’s documents and information still in their possession. After no more than 25 days, they had to provide the court with a declaration confirming that all sensitive data has been secured. Finally, between 20 and 90 days after the ruling, a forensic computer specialist “[had] the right to inspect and audit any computer systems” belonging to the VP, his wife, his business associate, and their gym to ensure that they had destroyed or permanently deleted the gym’s trade secrets.  This outcome would not have been possible, had the company  not followed the steps outlined above.

Leiza litigates unfair competition, non-compete and trade secrets lawsuits on behalf of companies and employees, and has advised hundreds of clients regarding non-compete and trade secret issues. If you need assistance with a non-compete or a trade secret misappropriation situation, contact Leiza for a confidential consultation at Leiza.Dolghih@lewisbrisbois.com or (214) 722-7108.

The Far-Reaching Claws of the Texas Non-Compete Statute

Wait-what-meme-rage-faceA recent case from a Texas Court of Appeals demonstrates that the Texas non-compete statute applies not only to the employment agreements or sale of business contracts, but to any contracts that contain provisions restraining trade.

In Wharton Physician Services, P.A. v. Signature Gulf Coast Hospital, L.P., the Corpus Christi Court of Appeals found that a liquidated damages clause in a recruiting contract was unenforceable under the Texas non-compete statute.

Gulf Coast hired Wharton to provide hospitalist services and to coordinate the hiring of individual physicians for Gulf Coast.  Their agreement contained the following clause that allowed Wharton to demand $100,000 in liquidated damages if Gulf Coast hired any of the physicians that Wharton had previously presented to Gulf Coast if the hiring took place within 6 months after Wharton’s contract’s termination:

If this Agreement is terminated by either party for any reason, then HOSPITAL [Gulf Coast] shall have the right to contract directly with all or some of the Hospitalist Physicians retained by GROUP [Wharton] to perform the services required by the terms of this Agreement . . . In the event that HOSPITAL, or any individual or entity otherwise affiliated with HOSPITAL, for work or services that would be provided at HOSPITAL, desires to contract directly with one or more of the HOSPITALIST physicians previously recruited retained, and presented to HOSPITAL by GROUP for hospitalist services at any time during the six (6) months period following the termination of this Agreement, HOSPTIAL shall pay to GROUP as liquidated damages in amount of $100,000 per physician.

The Court of Appeals applied the standard non-compete analysis to this liquidated damages clause finding that while the recruiting agreement itself was enforceable, the liquidated damages clause was not because it was a restraint on trade that was not supported by independent consideration.  The court explained its reasoning as follows:

“Gulf Coast promised to pay Wharton for services and Wharton promised to perform those services; however, none of those obligations amounted to additional consideration for Gulf Coast’s promise not to hire any physicians if the contract between Wharton and Gulf Coast was terminated.”

In sum, the court construed the liquidated damages clause “as a way to limit competition to Wharton from another company providing similar services.”  As such, it had to comply with the Texas Covenants Not to Compete Act’s requirements, which it failed to do.

Takeaway: When entering into a contract in Texas, the parties should consider whether any contract provisions may be viewed as a restraint on competition and an attempt to enhance or maintain prices.  If that’s the case, then such contractual provision might have to comply with the Texas non-compete requirements in order to be enforceable.

Leiza litigates non-compete and trade secrets lawsuits on behalf of COMPANIES and EMPLOYEES in a variety of industries, and has advised hundreds of clients regarding non-compete and trade secret issues. If you need assistance with a non-compete or a trade secret misappropriation situation, contact Leiza for a confidential consultation at Leiza.Dolghih@lewisbrisbois.com or (214) 722-7108.