Originally published by Zach Wolfe.
When I think about drafting a Texas non-compete, I think about these words to a song I liked in the 80s:
Freedom of choice, is what you got. Freedom from choice, is what you want.
It would be so much easier if we didn’t have so many choices, especially when drafting non-competes.
You’ve got two basic choices at the start. You can just cut and paste from a form, like my Plain-Language Non-Compete, or you can take the time to consider the client’s particular needs, the legal issues raised, and the practical considerations, and then draft accordingly. If you do the latter, here are my top 15 things to think about.
1. Does your client really want or need a non-compete?
This is not really a “drafting” tip. But before you start drafting a non-compete, you might want to ask the client “are you sure you really want a non-compete?” I explain why in The Most Effective Form of Non-Compete in Texas (or Anywhere). Spoiler alert: the answer is that you are better off with a happy employee than with an unhappy employee who was required to sign an airtight non-compete (if such a thing existed).
2. Should you include a choice of law clause?
If you’re drafting a non-compete for an employee working in Texas, can you improve the chance of enforcing the non-compete by including a choice of law clause selecting some other state’s law?
Probably not. There are two reasons for this.
First, you are probably not going to find a state that is significantly more favorable to non-competes than Texas. There are some things about Texas law that are favorable to the employee, such as the fact that you can’t get damages for breach of an overbroad non-compete (see no. 6) and the prohibition of industry-wide exclusions (see no. 9) But overall, Texas law is relatively friendly to non-competes.
So if you’re going to select some other state’s law (Delaware is a likely contender), you should at least take the time to understand whether that state’s law is actually better for your client.
But even then, there’s a second reason choosing another state’s law won’t work: Texas law on choice of law.
If the employee is working in Texas, a choice of law clause selecting some other state’s law is probably not going to be enforceable in a Texas court. I cover this in “This Stuff’s Made in New York City!” How Texas Courts Decide Which State’s Law Applies to a Non-Compete.
I say “probably” because there is some wiggle room in the three-part test for enforcing a choice of law clause. But in most cases you’re better off just avoiding this complication and selecting Texas law.
3. Which state’s law will apply?
We’ve been assuming the employee is going to work in Texas. But what if the employee is going to work outside of Texas? Will your Texas choice-of-law clause be enforceable? If not, what requirements of the other state’s law do you need to comply with?
This can get complicated. And your client probably doesn’t want to pay for you to spend hours researching the nuances of Oklahoma’s choice-of-law jurisprudence.
But here’s what I suggest. Assume there is a good chance the other state’s law will apply, and spend an hour researching the basic requirements of that state’s non-compete law. You might be surprised what you find. For example, Louisiana requires a non-compete to expressly state which parishes it covers.
Second, make the non-compete as narrow as reasonably possible (see nos. 6-9). That will tend to enhance its enforceability no matter which state’s law applies.
4. How do you meet the “ancillary” requirement?
Texas law requires a non-compete to be “ancillary to an otherwise enforceable agreement.” There is a lot of case law on what this means, some of it now obsolete. It boils down to two categories: (1) a non-compete tied to a confidentiality agreement and (2) everything else.
The most common way to meet the “ancillary” requirement for an at-will employee is to tie the non-compete to a confidentiality agreement. The Texas Supreme Court simplified this in the Alex Sheshunoff case. The court said the employer can meet the “ancillary” requirement by doing two things: agree to provide the employee confidential information and then actually provide the promised confidential information.
A corollary to this rule is that the employer can do the same thing by agreeing to provide specialized training and then actually providing such training.
Given this clear guidance from SCOTX, you’d be surprised how many Texas non-competes don’t expressly state that the employer will provide the employee with confidential information (or specialized training).
Not to worry. The Texas Supreme Court said in the Mann Frankfort case that the agreement to provide confidential information can be implied, if the nature of the employee’s work necessarily requires access to confidential information.
But why chance it? It’s so easy to include an express agreement to provide confidential information. Same for specialized training. And it helps if the training is actually “specialized.”
A harder question is how to make sure your client actually provides confidential information to the employee. I have one form of non-compete that includes a form for the employee to fill out 60 days later acknowledging that the employee has received confidential information.
Of course, after signing this acknowledgment the employee could still claim later that the information was not really confidential, but the signed form at least gives the employer’s litigation counsel good impeachment material.
On the other hand, what if the employer forgets to have the employee sign the acknowledgment? Now the evidence is messier, possibly creating a fact issue. For that reason, I stopped including the acknowledgment in my standard form of non-compete.
But it’s still an option to consider.
The next most common way to meet the “ancillary” requirement is to tie the non-compete to the sale of a business. I addressed this in Non-Competes in the Sale of a Texas Business. Generally, Texas law is friendlier to non-competes in this scenario.
My main drafting tip for a non-compete tied to the sale of a business is to make sure that the asset purchase agreement expressly states the buyer is obtaining the goodwill of the business. Protecting the goodwill is the rationale for allowing the non-compete, so you don’t want any ambiguity about whether the goodwill is being sold.
5. As to customers, should you include both a non-solicit and a non-compete?
It is very common for a Texas non-compete to have both a “non-solicitation” section and a separate non-compete section. The non-solicitation section will say, for example, that for two years the employee agrees not to solicit any person who was a customer or prospect of the employer during the last year of employment. The non-compete will more broadly prohibit competing with the employer. This means the non-solicit is really just a subset of the non-compete.
Why do lawyers draft it this way? And is it a good idea?
In my opinion, it’s generally a bad idea, although I admit this is more art than science.
First, let’s get one thing out of the way. A non-solicitation agreement is a form of a “covenant not to compete” and is therefore subject to the requirements of the Texas non-compete. See Is a Non-Solicitation Agreement a Non-Compete? This is one area of non-compete law where the Texas Supreme Court has not put form over substance.
That means including a separate non-solicitation section isn’t going to do anything to avoid the requirements of the statute.
So what’s the benefit? I think the idea is that the non-solicit is a sort of insurance policy. If a court finds the non-compete too broad, the employer can still fall back on the non-solicit, which is narrower and more likely to be found reasonable.
But tying the non-compete to “solicitation” creates practical problems of its own.
Here’s a familiar scenario that will illustrate what I mean:
Chris Customer: [answers phone] Hello?
Dawn Davis: Hey, Chris. It’s Dawn. How have you been?
Chris: Oh pretty good, Dawn. You know, just trying to keep up with all my construction projects.
Dawn: I hear you. I guess that’s a good problem to have.
Chris: Yeah, I can’t complain. So how are things going at Paula Payne Windows?
Dawn: Fine, I guess. But I’m not working there anymore. I’m the sales manager at Real Cheap Windows now.
Chris: Oh, cool. I didn’t know that. How do you like it so far?
Dawn: So far it’s great. We’ve got an excellent team here. We’re really doing good things for our customers.
Chris: Glad to hear it. Well it’s nice hearing from you. Will I see you at the kids’ soccer game Saturday?
Dawn: Yup, I’ll see you there.
Question: did “solicitation” just happen in this phone call? The problem is that there will almost always be a factual dispute about whether the communication at issue was solicitation. And the particular problem for the employer is that the customer will tend to back up the employee’s assertion that there was no solicitation.
Perhaps you could solve this problem by including a definition of “solicit” in the agreement. But now you’re creating more opportunities for argument and interpretation.
And there’s an additional, more subtle problem with solicitation: causation. Even if the employer proves the employee solicited the customer and the customer left, that doesn’t necessarily prove the solicitation caused the customer to leave. What if Chris testifies under oath, “I’ve gone to church with Dawn and her husband for over ten years, and I would have taken my business to Dawn regardless of whether she solicited my business or not.” Wouldn’t that evidence negate causation?
For all these reasons, I tend to favor tying the non-compete to doing business with the company’s customers, not solicitation of the company’s customers. Whether the employee has done business with the customer, i.e. providing goods or services to the customer for money, is usually a more objective fact.
6. In general, should you make the non-compete broad or narrow?
I think you know what I’m going to say. But it’s worth taking a moment to explain why.
The employer’s instinct is to make the non-compete as broad as possible. If you represent the employer, part of your job is to explain why that’s not in the client’s best interest. There are two main reasons for this.
First, it will be easier to get a temporary injunction enforcing the non-compete if the non-compete is enforceable as written. True, the trial court judge can enter a temporary injunction that only partially enforces the non-compete, but as a non-compete litigator I would much rather go into the courtroom defending a non-compete I know is already reasonable in scope.
Second, if a court finds that the non-compete was not reasonable as written, the court can reform the agreement, but the employer cannot recover damages that occur before reformation. See Tex. Bus. & Com. Code § 15.51(c). In practical terms, that means drafting an overbroad non-compete is going to cost your client a significant bargaining chip.
When you explain those two facts to your employer client, the client may start to understand the need to resist the instinct to make the non-compete as broad as possible. Instead, a good rule of thumb is to “narrow the non-compete until it hurts.” When your client’s reaction is “ouch, only one year, that’s going to hurt,” you know you’re on the right track.
7. How do you meet the reasonable time period requirement?
Like I said, shorten the time period until it hurts. Texas courts have enforced non-competes as long as 3-5 years, but why chance it? The time period must be no longer than necessary to protect the employer’s legitimate interest, which usually means goodwill and confidential information. That usually means no more than two years. And one year is even better.
8. How do you meet the reasonable geographic area requirement?
There are Texas cases that, despite the command of the statute, you don’t need to have an express geographic limitation if there is a reasonable limitation on the scope, but again, why risk it? Put some geographic limitation in, even if it’s broad. Better yet, make the geographic scope as narrow as possible. The rule of thumb is that it should match the territory the employee is actually going to be responsible for.
9. How do you meet the reasonable scope requirement?
This is where I see the most mistakes in Texas non-competes. It seems many lawyers who draft agreements with non-competes are not aware that Texas law generally prohibits an “industry-wide exclusion.” I explained this in Burning Down the Haass: The Industry-Wide Exclusion Rule in Texas Non-Compete Law. (Again with the 80s songs.)
There are exceptions to the industry-wide exclusion rule, but again, why chance it? It’s best to limit the non-compete to customers the employee deals with or learns confidential information about while working for the company.
10. Should you include stipulations that the non-compete is enforceable, that a breach will cause irreparable injury, etc.?
You see clauses like this all the time. Essentially, these are just attempts to have the employee waive objections to enforceability.
Do clauses like this have any legal effect? Texas law is unsettled. Usually the court will cite a clause like this as an additional reason for enforcement, without saying the clause is dispositive. I don’t think I’ve seen any case that says, for example, that a stipulation that a breach will cause irreparable injury is conclusive.
My personal opinion is that these clauses should be given exactly zero weight. You can’t waive a public policy issue. And I don’t think private parties can change the requirements for obtaining an injunction any more than they could stipulate to different rules of evidence or procedure.
Despite my personal view, do I still include clauses like this when I draft a non-compete for an employer? Yes, of course. It doesn’t hurt. And it can help in cross examination of the employee.
How? You can’t expect me to give away all my secrets.
11. Should you include a tolling clause?
A tolling clause says that the time period of the non-compete will be extended by the amount of time that the employee is in breach. I’m starting to see more of these.
These clauses strike me as introducing more potential uncertainty than they are worth. A time period of one year from termination is objective and usually easy to apply. Figuring out the period of time the employee has been in breach can present a factual dispute. If you’re the employer, the last thing you want is to add yet another potential fact issue.
The court might even say the tolling clause renders the time period too indefinite to be enforced. I haven’t seen a case on this, but if I represent the employee I might at least make the argument.
12. Should you include a liquidated damages clause?
A liquidated damages clause specifies a specific amount of damages for a breach. I covered the requirements of a liquidated damages clause generally in Liquidated Damages Lessons from the Stormy Daniels Settlement.
I don’t like liquidated damages clauses in non-competes. It’s usually not that hard to calculate actual damages after the fact; in most cases it’s lost profits. But coming up with a dollar amount in advance that reasonably estimates what the actual damages are likely to be is difficult. For these reasons, you’re likely to have an argument over whether the liquidated damages clause is enforceable. That’s one more argument the employer doesn’t need.
If you do include a liquidated damages clause, be sure you also include a clause expressly stating that the employer can still obtain injunctive relief in addition to the liquidated damages. Otherwise, a court might say the liquidated damages are the employer’s exclusive remedy.
13. Can you avoid enforceability problems by structuring the non-compete as a forfeiture clause?
The short answer is no. If the agreement says the employee is free to compete but will forfeit his equity ownership in the company if he does so, the reasonableness requirements for Texas non-competes could still apply. And even if the court doesn’t consider the agreement a non-compete, it would still have to be reasonable.
For the longer answer, see my post When Is a Forfeiture Clause a Non-Compete?
The bottom line is that structuring the non-compete as a forfeiture clause—as opposed to an express prohibition on competition—won’t necessarily avoid enforceability issues, and if you do go the forfeiture route, you should still include reasonable limitations on time period, geographic area, and scope.
14. Can you improve the effectiveness of the non-compete by including severance pay? Garden leave?
When employees consult with me about non-competes, I sometimes suggest that if the employer is going to require a one-year non-compete, for example, then maybe the employee should ask for one year of severance pay. The rationale is that if the employee is going to sit out of the industry for a year, she should at least get paid for that year.
There is a certain logic to this, but of course that doesn’t mean employers will like it. Companies don’t usually like paying people to do nothing.
Still, there could be a benefit to the employer. This is why you sometimes see “garden leave” provisions. Under garden leave, the employee technically remains employed by the company for some period of time but is no longer actively doing anything for the company. The idea is that it’s easier to enforce a non-compete against a current employee than a former employee. Plus, competing with the employer while still employed would usually violate the employee’s limited “fiduciary” duty. See Fiduciary Duty Lite: What Employees Can and Can’t Do Before Leaving.
I don’t have as much experience with non-competes tied to garden leave, but it’s an idea employers should at least consider.
15. Can you draft an effective non-compete in the middle of employment? When the employee is on the way out the door?
The short answer? It’s hard, but not impossible. And it’s easier to do it in the middle than at the end.
The problem, in a word, is consideration. If the employee is already working for the company and has already received confidential information, what’s the new consideration for the non-compete?
Typically, the agreement in this situation will recite continued employment as consideration. But to improve the argument for enforceability, the employer should try to tie the new non-compete to a promotion, a higher level of responsibility, and/or increased access to confidential information.
Having the employee sign a non-compete after notice of termination is usually not going to work, even if the employer agrees to pay severance for it. Traditionally, a mere agreement to pay money has not satisfied the “ancillary to an otherwise enforceable agreement” requirement. But you can try. And feel free to be creative.
Like another song says, freedom’s just another word for nothin’ left to lose.
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Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.
These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.
Curated by Texas Bar Today. Follow us on Twitter @texasbartoday.
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