No question in my mind that the economy is picking up. I am seeing more noncompete issues than in previous years. My humble explanation is that employees who did not like their jobs are now looking and starting to find opportunity. But many of these employees are probably encumbered with some form of covenant not to compete, which will affect their new employment if they move to a competing firm.
Employees are looking around in a better economy
Some of you reading this article may be considering a move or may be hiring an employee that is transitioning. I am a big believer in a liquid employment market, but employers and employees should be careful about handling noncompetition agreements.
I hear a lot of “they aren’t enforceable”, when, in fact, they are very enforceable.
Noncompete tied in with equity
One topic I want to bring to your attention concerns noncompetition restrictions supported by equity in a company. Often a company extends options to a “C” level employee in addition to other compensation. Clearly, the company’s incentive is to give the new employee some buy-in on the success of the company. When done properly, equity can be used to support a noncompetition agreement.
Texas law requires noncompetition agreements to be ancillary to an otherwise enforceable agreement that is designed to impose no greater restraint on an employee than is necessary to protect the goodwill or other business interest of the company. This means that a company can’t just have an employee agree to a noncompete without it being part of another agreement designed to protect a company’s business interests. That is why many of you have seen confidentiality agreements and nondisclosure agreements partnered with noncompetition agreements. This arrangement is a classic Texas noncompetition agreement.
Confidential information doesn’t always work as a noncompete tie-in
For many years practically the only value, to support a noncompetition agreement, a company could give a new employee was confidential information. Nearly every noncompetition agreement I draft has the company giving some kind of confidential information to the employee in exchange for the employee’s promise not to compete or solicit.
The problem with confidential information is that many companies don’t treat their confidential information, confidentially. Therefore, when it comes time to enforce them the departed employee makes the argument that the information wasn’t confidential. This leads to the typical fight over whether the information was in fact confidential. There may be an alternative that provides more certainty for a company and that is by giving the right employees equity.
Consideration for a noncompete that is reasonably related to an interest worthy of protection, such as trade secrets, confidential information or goodwill, satisfies the statutory nexus; so said the Texas Supreme Court in Marsh v. Cook. Marsh is not a new case, but it came to mind when I provided counsel to an individual who had signed a noncompete supported by stock options. In that case the options were revocable.
Why stock options are a good tie-in
I have no doubt that if a company offers an employee stock options and the employee exercises those stock options a Texas court is going to hold that employee to the noncompete, assuming it is otherwise valid. Marsh and more recent cases tell us that.
The Marsh court stated, “awarding to Cook stock options to purchase MMC stock at a discounted price provided the required statutory nexus between the noncompete and the company’s interest in protecting its goodwill. Exercising the stock options to purchase MMC stock triggered the restraints in the noncompete.” Marsh linked the interests of a key employee with the company’s long-term business interests. Stockholders are owners. The Court stated, “Owners’ interests are furthered by fostering the goodwill between the employer and its clients. The stock options are reasonably related to the protection of this business goodwill. Thus, this covenant not to compete is ancillary to an otherwise enforceable agreement.” I believe on a practical matter that had Marsh been required to forfeit his options at termination of employment, the Court would probably have gone a different direction.
Given the increase in employment opportunities, businesses and employees are going to make changes. Companies should consider giving equity, to the right employees, to add an additional layer of loyalty to the employee/employer relationship. Of course, never give something without getting something in return. In this case, that should be a noncompetition agreement.
Employees transitioning should understand that Marsh was just the beginning of the Texas judiciaries’ liberalization of the law regarding noncompetition agreements. If you are encumbered by a noncompetition agreement, be above board. Failing to do so could lead to liability for your new employer and you, the new employee. If your company presents you with a noncompete agreement, negotiate to the extent you can.
Time to take a look at your noncompetition agreements
If your company has a form noncompetition agreement that it has been using for some time, it may be time to take a critical look at it. As an employee, if your company presents you with or you are encumbered by a noncompetition agreement, make sure you understand its ramifications and your obligations.
As always, MelderLaw is here to help.