Texas Supreme Court Changes Non-Compete Landscape

This week the Texas Supreme Court issued an opinion that will seriously affect the way non-compete cases are analyzed under Texas Law. In Sheshunoff Management Services, Inc. v. Kenneth Johnson and Strunk & Associates, (Tex. 10/20/06), the Court partially overturned its prior reasoning in Light v. Centel Cellular Co. 883 S.W.2d 642 (Tex. 1994), and with it 12 years of lower court case law that has been based on Light.

At the heart of the issue is the question of whether an at-will employee who signs a non-compete covenant is bound by that agreement if, at the time the agreement is made, the employer has no corresponding enforceable obligation. Under the Court's previous decision in Light, the answer in Texas is always "no." Under the Court's decision this week in Sheshunoff, the answer is now "maybe." The Sheshunoff decision holds that an at-will employee's non-compete covenant, which is not originally enforceable, becomes enforceable when the employer performs the promises it made in exchange for the covenant. This is a really important shift in the state of the law that will affect a great many employees but it can be a little confusing if you don't deal with this stuff every day. So let's back up a little.

The Texas Covenants Not to Compete Act states:

[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.

TEX. BUS. & COM. CODE § 15.50(a).

In the Light decision, the Court held that "otherwise enforceable" agreements under the Act can emanate from at-will employment (meaning employment without a fixed term duration) only if the consideration for the promise not to compete is not illusory at the time the agreement is made. Under Light, an employer's promise to share confidential information with an employee in the future was considered to be illusory because the employer was free to fire the employee on day two of his or her employment and would have no duty to share the confidential information that was supposedly being offered in exchange for the noncompete. Many a non-compete agreement has been thrown out by the courts because of this fatal flaw.

This week's decision in Sheshunoff reinterprets the language in the non-compete Act 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 mean that the covenant need only be "ancillary to or a part of" the agreement at the time the agreement is made. Sheshunoff at p. 11. Therefore ". . . a unilateral contract formed when the employer performs a promise that was illusory when made can satisfy the requirements of the Act [if and when the employer actually provides the consideration promissed]." Thus a non-compete agreement that is unenforceable due to the employer's failure to provide the promissed consideration (i.e. confidential information) can be made enforceable by the employer simply by following through on its original promise and providing the consideration later.

The Court's opinion goes through a rather protracted analysis of the legislature's intent in crafting Section 15.50 (a) of the Act. It serves little purpose to address it here except to say that, in my opinion, analysis of legislative intent is irrelevant with regard to this particular provision because it unambiguously 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." The Court's decision this week in Sheshunoff rewrites the clear and unambiguous language of statute in order to make it easier for a companies to enforce non compete agreements against former employees.

So what are the practical affects of this decision?

  • Less Certainty - This decision throws non-compete issues back into flux under Texas Law. Employees, who often have very little bargaining power when facing the Hobson's choice of signing a non-compete or being shown the door by an employer must now deal with the fact that it will be, in most cases, easier for their employer to enforce a non-compete agreement against them following their departure from the company. This decision will create problems for employers as well, however, who may have greater difficulties assessing the enforceability of a non-compete agreement applicable to a prospective employee prior to making a hiring decision.
  • More litigation - The Court's decision this week destroys the body of law regarding non-competes that has been developed over the last 12 years since Court's decision in Light. Now instead of addressing the limited issue of whether the consideration offered in return for a non-compete covenant was illusory when made, the parties and the Court's will need to look at the entire course of dealing between the employer and employee to determine if the once a illusory promise was later made binding by an employer's later tender of consideration (i.e. confidential information.) Questions will arise as to whether such a tender was legitimate in the course of business or made only once an employee's unhappiness or desire to leave employment became apparent in an effort to activate an otherwise unenforceable non-compete clause. Additionally, litigation will be created by the fact that the Court's decision this week greatly shifts the focus in non-compete enforcement cases away from the more clear-cut statutory analysis under the Light decision to the equitable issues of whether the agreement in question is reasonable or not under the particular factual circumstances in each case.

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