The Fifth Circuit Rules Industry-Wide Noncompete Agreements Are Not Enforceable

static1.squarespace.comThe Fifth Circuit Court of Appeals recently considered whether a travel agency’s noncompete agreement with its employee was enforceable under Texas law.  It concluded that because the agreement did not have geographic limits, was not limited to the travel agency’s customers with whom the employee actually worked during her employment, and included the entire travel agency industry, the noncompete was unenforceable.

In analyzing the noncompete clause, the court in Karen D’Onofrio v. Vacation Publications, Inc., provided a useful refresher as to what types of noncompete agreements are legal in Texas and what types are illegal and, therefore, not enforceable.   The court confirmed that noncompete restraints that preclude employees from working in any capacity in a particular industry are not enforceable. Thus, when it comes to noncompete agreements, bigger is not always better.

What covenants not to compete are legal in Texas?

First of all, Texas law recognizes that reasonable covenants not to compete serve the legitimate business interest of preventing departing employees from “using the business contacts and rapport established” during their employment to take the employer’s clients with them when they leave.

Thus, a covenant not to compete is enforceable under Texas law 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.”  Tex. Bus. & Com. Code § 15.50(a).

In the case of personal services occupations, such as sales persons, the employer has the burden of showing the reasonableness of its noncompete agreement.  Thus, for example, an employer who is asking a court to enforce a 20-mile covenant not to compete, will have to establish why the 20-mile – as opposed to a 10-mile – radius is reasonable.

What types of covenants not to compete are illegal in Texas?

As a general rule, under Texas law, covenants not to compete that extend to clients with whom the employee had no dealings during his or her employment or amount to industry-wide exclusions are overbroad and unreasonable and will not be enforced by the Texas courts.  Similarly, the absence of a geographical restriction will generally render a covenant not to compete unreasonable and, therefore, unenforceable.

Was D’Onofrio’s covenant not to compete enforceable?

D’Onofrio’s noncompete agreement prohibited her — for a period of 18 months after her employment with the travel agency — from, among other things, working “in any capacity” for “any direct or indirect competitor of [the travel agency] in any job related to sales or marketing of cruises, escorted or independent tours, river cruises, safaris, or resort stays” or doing any business with “any person or entity” who had purchased a cruise or other travel product from the travel agency in the preceding 3 years.

According to the court of appeals, this covenant amounted to an industry-wide restriction, which prevented D’Onofrio from working in any job related to the sales or marketing of not just cruises, but also a host of other travel products—and was not limited as to either geography or clients with whom D’Onofrio actually worked during her employment.  Therefore, the Fifth Circuit Court of Appeals concluded that D’Onofrio’s covenant not to compete with her travel agency was unreasonable as written.

When a Texas court finds a noncompete agreement unenforceable, what does that mean for the employer?

If a court determines that a covenant not to compete does not contain reasonable time, geography, and scope limitations, but is otherwise enforceable, then the court shall reform, i.e. rewrite, the noncompete agreement to make it reasonable.  For example, a court can change a 50-mile radius in a non-compete agreement to a 20-mile radius or change an 18-month restriction to a 6-month restriction.  

Texas Bar Association Top TenBOTTOM LINE: In the D’Onofrio case, the court of appeals sent the case back to the lower court directing it to rewrite the agreement.   Texas employers should be aware that any time a court has to rewrite a noncompete because it is overbroad and unreasonable, there are negative consequences for the employer – more attorney’s fees, more time spent in litigation, and an inability to recover damages from the employee.  

Therefore, it is important to make sure that noncompete agreements are written properly from the beginning rather than rely on the courts’ ability to rewrite them during litigation.

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.

What Are Acceptable Non-Solicitation Restraints for Sales Employees?

maguire_primIn Texas, it is common for sales employees in many industries to have a non-solicitation clause in their employment agreements, which prohibits them from soliciting company clients for a certain period of time after they leave the company’s employment.  Such non-solicitation clauses are enforceable under the Texas Covenants Not to Compete Act as long as they are reasonable and supported by proper consideration.  What is “reasonable,” however, is often a major point of contention between the company and the sales employees or such employees’ new employers.  

A recent opinion from the Thirteenth Texas Court of Appeals provides a good illustration of what is not a reasonable non-solicitation restraint.  In Cochrum v. National Bugmobiles, Inc., a trial court entered an injunction against a pest control technician who left one pest control company to work for another. The injunction prohibited Cochrum from soliciting business from any of National Bugmobiles’ 19,700 customers on its client list compiled over the course of eight or nine years during which Cochrum worked there, even though the employee testified that he only serviced approximately 300 customers during his tenure with National Bugmobiles.

Cochrum argued that he cannot in good faith comply with the injunction because he has no idea who the 19,700 customers are.  The company argued that in order to comply with the injunction, he should ask any prospective customer whether they received services from National Bugmobiles, and if they had, refrain from soliciting their business.  While the trial court was satisfied with this approach, the Court of Appeals rejected it calling it “simplistic” and “fatally vague” in that the injunction order failed to identify the customers that Cochrum was prohibited from soliciting, as required under Texas law.

Thus, as far as the non-solicitation requirements were concerned, the Court of Appeals modified the temporary injunction by striking down the following language for being too vague:

  • Diverting any business whatsoever from Bugmobiles by influencing or attempting to influence any of the customers of Bugmobiles whom Cochrum may have dealt with at any time or who were customers of Bugmobiles on February 13, 2017 or had been customers of Bugmobiles thereto;
  • Servicing any client that was under contract with or was being serviced by Bugmobiles as of February 132017 by directly or indirectly owning, controlling or participating in the ownership or control of, or being employed by or on behalf of, or engaging in any business which is similar to and is competitive with the business of Bugmobiles.

Instead, the Court of Appeals left the following much more specific language in the injunction order prohibits the technician from:

  • Diverting any business by soliciting or attempting to solicit any of approximately 300 customers of Bugmobiles whom Cochrum dealt with at the time of his resignation from Bugmobiles on February 13, 2017.

TexasBarToday_TopTen_Badge_VectorGraphicCONCLUSION: While a non-solicitation clause that prohibits a sales employee from soliciting all company customers may sometimes be justified, most of the time it is much more reasonable to limit the non-solicitation restraint only to the customers and prospective customers with whom the sales employee directly interacted rather than every customer in the company’s database.  This is true, especially when the entire customer list is much larger than the subset of customers with whom the sales person dealt.  

When enforcing a non-solicitation clause, a company should always consult with an attorney to determine the scope of the enforcement given a particular sales employee’s area, the circumstances surrounding a his/her departure, and the size of the company customer list.

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.

Non-Compete Agreements in Texas: The Devil is in the Details

Last week, the Fifth Court of Appeals of Texas in U.S. Risk Insurance Group, Inc. et al. v. Woods reminded us again that a non-competition agreement must be reasonable and must include a correct entity, or it will not be enforceable.

In Woods, an insurance broker signed an Employment, Confidentiality and Non-Compete Agreement (Agreement) when he began working for U.S. Risk Brokers, Inc. (USR).  Although Woods was working for and soliciting insureds on behalf of USR, the Agreement was between Woods and USR’s holding company – U.S. Risk Insurance Group, Inc. (USRIG). USR was not a party to the Agreement.

The Non-Competition provision in the Agreement stated the following:

Additionally, for a period of ninety (90) days after the last day of Employee’s employment following Employee’s voluntary resignation from the Company provided that the Company elects to continue the Employee’s salary during the ninety (90) day period, Employee agrees that Employee shall not become associated with, employed by, or financially interested in any business operation which competes in the business currently engaged in by the Company or any of its subsidiaries or affiliates.  The phrase “business currently engaged in by the Company” includes, but is not limited to, the types of activities in which the Company was engaged during Employee’s tenure .

When Woods resigned and went to work for a USR’s competitor, USR filed a lawsuit against him alleging the breach of the Agreement.

The Fifth Court of Appeals found that the Non-Competition provision was unenforceable against Woods because it was unreasonable as to the scope of the restrained activity.  Not only did it prohibit Woods from engaging in the type of business activity that he had performed for USR, but it prohibited him from engaging in any business that USRIG, the holding company, engaged in.

The Court of Appeals also held that the non-solicitation clause in the Agreement was unenforceable by USR because the Agreement was between USRIG and Woods, and USR was not a party.   Thus, because the non-solicitation clause only prohibited Woods from soliciting “insureds” of USRIG, he was free to solicit any customers of USR.

CONCLUSION:  When drafting or enforcing a non-compete in Texas, remember these simple rules:

1.  The limitations as to time, geographic area, ans scope of activity restrained must be reasonable.

2. When applied to personal services occupation, a restraint on client solicitation is overbroad and unreasonable if it extends to clients with whom the employee had no prior dealings during his employment.

3. An industry-wide bar is unreasonable.

4. Make sure the non-compete agreement is with the correct entity or the entity is defined broadly enough to include its affiliates who employ the covered employees.

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.

Why Adding an Arbitration Clause to a Non-Compete Agreement Is a Good Idea.

In Nitro-Lift Techs., L.L.C. v. Eddie Lee Howard, et al.the U.S. Supreme Court once again expressed its strong support of the Federal Arbitration Act (FAA), in finding that where an arbitration clause in a non-competition agreement is valid, all other disputes related to the non-compete agreement, including its enforceability, should be decided by an arbitrator rather than the court.

In Nitro-Lift, the dispute arose from an employment contract between Nitro-Lift Technologies, L.L.C., and two of its former employees, which contained a non-compete clause and the following arbitration clause:

“Any dispute, difference or unresolved question between Nitro-Lift and the Employee (collectively the “Disputing Parties”) shall be settled by arbitration by a single arbitrator mutually agreeable to the Disputing Parties in an arbitration proceeding conducted in Houston, Texas in accordance with the rules existing at the date hereof of the American Arbitration Association.”

When the two employees went to work for the Nitro-Lift’s competitor, the company served them with a demand for arbitration, claiming that they breached their non-compete agreement.  Instead of arbitrating the dispute, the employees filed a lawsuit in a state court alleging that the non-compete agreement violated the state law and was null and void.  The state court dismissed their case after determining that the arbitration clause in their employment agreement was valid, but the Oklahoma Supreme Court reversed the lower court and declared that the FAA arbitration clause gave way to Oklahoma’s public policy regarding non-compete agreements and, without addressing validity of the arbitration clause, declared the non-compete “void and unenforceable” under the Oklahoma state law.

The U.S. Supreme Court reversed the Oklahoma Supreme Court and held that under the FAA, it is for the arbitrator – and not the state court – to decide whether a covenant not to compete violates the applicable state law.

PRACTICAL IMPLICATIONS:

The Nitro-Lift decision is a significant ruling for employers, many of which have gravitated toward arbitration agreements to reduce their exposure to costly and time-consuming employment litigation.

The employers can now feel confident that placing an arbitration clause in an employment agreement will allow them to avoid often-messy litigation of the non-compete provisions.

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.