Emerging Trends In Non-Compete Agreements: A Light Decision
By R. Edward Perkins and
Steven O. Grubbs
For a number of years, at-will employers in Texas struggled to satisfy certain covenant not to compete requirements created by Light v. Centel Cellular Co. of Texas, 883 S.W.2d 642 (Tex. 1994). In particular, employers grappled with the issue of whether a promise to provide confidential information to an at-will employee was sufficient consideration to support a covenant not to compete. After Light, several appellate courts determined that such a promise, without actually providing the confidential information at the time of the agreement’s execution, was illusory and would not support a convent not to compete. Recently, however, the Supreme Court determined that the lower courts were losing sight of the forest for concentration on a single tree.
In Alex Sheshunoff Management Services, L.P. v. Johnson, 209 S.W.3d 644 (Tex. 2006), the Supreme Court clarified that the promise to provide confidential information to an at-will employee will support a covenant not to compete so long as the employer actually provides confidential information to the employee during the employment relationship. The Court overturned the unrealistic requirement that confidential information must be exchanged instantaneously with the execution of the agreement containing the covenant not to compete. In essence, the Court approved the use of a unilateral contract to support a covenant not to compete. Despite that holding, the Court expressly recognized that, in many aspects, Light remains good law. Thus, an employer must still understand Light to draft an enforceable covenant not to compete.
This paper, through its discussion of relevant case law, will explain how to draft an effective covenant not to compete by examining the key elements for non-competition covenants provided by Texas statute and common law.
I. Texas Covenants Not To Compete Act
Before fully understanding the seminal Supreme Court cases noted above, one must first begin with the statutory requirements provided by the Texas Covenants Not to Compete Act. As codified in section 15.50 of the Texas Business & Commerce Code, the Act provides the following two requirements:
(1) The covenant must be “ancillary to or part of an otherwise enforceable agreement at the time the agreement is made;” and
(2) The covenant must contain “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 promise.”
See Tex. Bus. & Com. Code § 15.50(a). The first requirement was the source of contention in Light and Sheshunoff.
II. Common Law Requirements Imposed By Light And Sheshunoff
A. The Light Decision
Prior to Sheshunoff, Light was a seminal case for covenants not to compete. In Light, Light, an at-will employee, was hired in 1985 to sell pagers. Two years later, Light was required to sign an employment agreement containing a covenant not to compete. In addition to the covenant not to compete, the agreement included several other provisions, including the following: both parties agreed that Light was an employee at-will; Light would be paid a salary plus commissions; Light’s employer would provide her a package of employee benefits; her employer would provide her initial and on-going specialized training; Light would agree to give her employer 14 days’ notice before terminating her employment; and she would provide her employer with an inventory after giving notice of termination. Shortly after signing the agreement, Light resigned and litigation ensued over the enforceability of the covenant not to compete.
On appeal, the Texas Supreme Court determined at the outset that the Covenants Not to Compete Act applied to the controversy and that section 15.50 involved two main inquiries, which are as follows.
1. “Otherwise enforceable agreement”
First, the Court was faced with the question of whether there was an “otherwise enforceable agreement.” In order to answer this question, the Court disregarded the covenant not to compete and then examined whether the remaining promises within the employment agreement were enforceable.
The Court decided that many of the remaining promises were illusory and unenforceable. The Court recognized that, when dealing with an at-will employment relationship, there cannot be an otherwise enforceable agreement if it is based on a promise of continued employment. “Such a promise would be illusory because it fails to bind the promisor who always retains the option of discontinuing employment in lieu of performance.” In other words, a promise of continued employment is truly no promise at all in an at-will employment relationship. Regardless, the Court emphasized the fact that “otherwise enforceable agreements” can emanate from at-will employment so long as the consideration for any promise is not illusory (i.e., not based solely on a promise of continued employment). The Court also determined that the promises to pay salaries and commissions and to provide a benefits package in the future were illusory because, under the basic principles of contact law, a promise to provide consideration in the future is no consideration. Such a promise is illusory.
After disregarding the illusory promises, the Court was left with three promises capable of serving as consideration for an agreement, which are as follows: (1) the employer’s promise to provide “initial specialized training” to Light; (2) Light’s promise to provide 14 days’ notice when terminating her employment; and (3) Light’s promise to provide an inventory of all of her employer’s property upon termination. The Court opined that, even if Light resigned or was fired after entering into this agreement, her employer was still required to provide Light with the specialized training. Also, the two latter promises were not rendered illusory by the fact that her employer could terminate Light at will. Accordingly, the Court determined that the first prong of the test had been satisfied, meaning there was an “otherwise enforceable agreement.”
2. “Ancillary to or part of”
The next step was to ascertain whether the covenant not to compete was “ancillary to or part of” the “otherwise enforceable agreement.” In the Light opinion, the Court set forth two requirements necessary for a covenant not to compete to be considered “ancillary to” an otherwise enforceable agreement between an employer and employee:
(1) the consideration given by the employer in the otherwise enforceable agreement must give rise to the employer’s interest in restraining the employee from competing; and
(2) the covenant must be designed to enforce the employee’s consideration or return promise in the otherwise enforceable agreement.
Without satisfying both of these elements, a covenant not to compete cannot be ancillary to an otherwise enforceable agreement and is unenforceable.
In footnote 14, the Court held that a covenant not to compete will be “ancillary to” an “otherwise enforceable agreement” if an employer “gives an employee confidential and proprietary information or trade secrets in exchange for the employee’s promise not to disclose them.” In that instance, the covenant not to compete would be “ancillary to” an “otherwise enforceable agreement” because the employer is protecting a worthy interest of keeping the information confidential by having the employee agree to not disclose the information and the covenant is designed to protect against the disclosure of such information.
Nonetheless, the Court concluded that the covenant not to compete in question was not ancillary to an otherwise enforceable agreement. The Court determined that, while the employer’s promise to train Light may have involved the disclosure of some confidential or proprietary information, the covenant not to compete was not designed to enforce Light’s return promises of fourteen days’ notice and to provide an inventory. Since Light did not have an agreement not to disclose confidential proprietary information, the court ruled that the covenant not to compete between Light and her employer was not ancillary to an otherwise enforceable agreement between them. Thus, the covenant not to compete was unenforceable.
3. Light’s infamous footnote and its progeny
While the body of Light’s decision appeared to have been fairly straight-forward, a footnote provided by the Court took a life of its own in the lower courts. During its discussion of the enforceability of the agreement between an employer and employee, the Court included footnote 6 to state that a unilateral contract could still be created even though only one promise was not illusory. Stated otherwise, a unilateral contract could still be formed by accepting the non-illusory promise. In the footnote, the Court provided the following example:
[S]uppose an employee promises not to disclose an employer’s trade secrets and other proprietary information, if the employer gives the employee such specialized training and information during the employee’s employment. If the employee merely sought a promise to perform from the employer, such a promise would be illusory because the employer could fire the employee and escape the obligation to perform. If, however, the employer accepts the employee’s offer by performing, in other words by providing the training, a unilateral contract is created in which the employee is now bound by the employee’s promise. The fact that the employer was not bound to perform because he could have fired the employee is irrelevant; if he has performed, he has accepted the employee’s offer and created a binding unilateral contract. To form such a unilateral contract, however, (1) the performance must be bargained-for so that it is not rendered past consideration, and (2) acceptance must be by performance and not by a promise to perform. Such a unilateral contract existed between Light and United as to Light’s compensation. But such unilateral contract, since it could be accepted only by future performance, could not support a covenant not to compete inasmuch as it was not an “otherwise enforceable agreement at the time the agreement is made” as required by § 15.50.
This footnote was cited for support by a number of lower courts to declare covenants not to compete enforceable. In particular, certain courts focused on the last sentence of this footnote to effectively negate the use of a unilateral contract to support a covenant not to compete.
The opinion in Trilogy Software, Inc. v. Callidus Software, Inc., 143 S.W.3d 452 (Tex. App.—Austin 2004, pet. denied), provides a good example of the tangent taken by several courts from footnote 6. In Trilogy, a computer programmer, on his first day of work for Trilogy, was required to sign an agreement containing a nondisclosure agreement and a covenant not to compete. The programmer was subsequently laid off, and he went to work for a competitor. During the subsequent litigation, Trilogy attempted to enforce the covenant not to compete. However, the trial court refused to enforce the covenant.
On appeal, Trilogy asserted that Light supported its argument that its promise to give Liu access to confidential information and training in the future was sufficient consideration to support the nondisclosure agreement. However, the Austin Court of Appeals disagreed. Rather, it found that the promise to provide confidential information or training was illusory because it was conditioned on continued employment. Even though the confidential information was actually provided to the programmer on the date that he entered into the covenant not to compete, the court contemplated a situation where the employer could terminate him before providing him with the information. In that instance, the promise to provide the information in the future was illusory because it was based on a promise of continued employment in an at-will employment relationship.
Also, the court believed that, since section 15.50 provides that the covenant must “ancillary to or part of an otherwise enforceable agreement at the time the agreement is made,” a unilateral contract must be consummated instantaneously with the covenant not to compete. Since the programmer was not provided with the confidential information or training at the same time that he signed the agreement, there was not an otherwise enforceable agreement at that time thereby violating section 15.50. Forget the fact that the programmer actually received confidential information later in the same day that the agreement was signed.
The court provided in a footnote that this analysis causes practical problems. The court stated, “[E]ven a momentary pause between [the employee’s] signature and [the employer’s] provision of information and training could conceivably preclude enforcement of the non-compete agreement.” Thus, under the Trilogy analysis, a covenant not to compete could not be upheld when it was based on a unilateral contract and when the provision of confidential information was conditioned on continued employment.
The Dallas and Fort Worth Courts of Appeals also found in Strickland v. Medtronic, Inc., 97 S.W.3d 835 (Tex. App.—Dallas 2003, pet. dism’d w.o.j.) and 31-W Insulation Co. v. Dickey, 144 S.W.3d 153 (Tex. App.—Fort Worth 2004, no pet.), that a promise to provide confidential information to an at-will employee is still illusory “because it necessarily depends on a period of employment.”
After these post-Light decisions, it seemed that an employer would not be able to enforce a covenant not to compete against an at-will employee unless: (1) it provided the confidential information to the employee at the instant in which the employee executed the covenant not to compete; or (2) it included language within the agreement unequivocally providing that the employer will provide the employee with the confidential information regardless of whether he continues his employment. Obviously, this created an absurd and unrealistic result.
Under the former option, rarely would an employer be willing to provide a new employee with confidential and trade secret information as soon as that employee is hired. Surely, employers would like to know they can trust their new hire before departing with such sensitive information.
The alternative is similarly ridiculous. Under that scenario, if an employer terminates his employee before providing him with the confidential information, the employer would have to provide its employee with the confidential information in order to subsequently enforce the covenant not to compete. Before Sheshunoff, these seemed to be the ominous “options” for an employer who desired a covenant not to compete from an at-will employee.
B. Sheshunoff’s Decision
Through Sheshunoff, the Texas Supreme Court foreclosed the hyper-technical approach engaged by Light’s progeny. In Sheshunoff, Johnson was a current at-will employee for Alex Sheshunoff Management Services, L.P. (“ASM”) when he was required to sign an employment agreement that contained a covenant not to compete. The agreement contained a promise by ASM to provide training and access to confidential information. ASM also agreed to give Johnson two weeks’ notice before terminating him, as long as his termination was not due to misconduct. In return, Johnson agreed that while he was employed by ASM and for one year after, he would not “solicit or aid any other party in soliciting any affiliation member or previously identified prospective client or affiliation member.”
Several years later, Johnson resigned and went to work for a competitor of ASM. This competitor subsequently sought a declaratory judgment holding that the covenant not to compete was unenforceable. The trial court agreed with the competitor and found that the covenant was not enforceable. On appeal, the Austin Court of Appeals again cited Light’s footnote to support its holding that the promise to provide confidential information in the future was illusory and could not support a covenant not to compete. See Alex Sheshunoff Mgmt. Serv., L.P. v. Johnson, 124 S.W.3d 678, 686-87 (Tex. App.—Austin 2003, rev’d). As a result, the court decided there was not an “otherwise enforceable agreement” thereby rendering the covenant not to compete unenforceable.
In late 2006, the Texas Supreme Court overruled the Austin Court of Appeals’ decision. In doing so, the Court “modified” its opinion in Light, in particular, footnote 6. “Upon further review of the Act and its history, ” we disagree with footnote six insofar as it precludes a unilateral contract made enforceable by performance from ever complying with the Act because it was not enforceable at the time it was made.” Sheshunoff, 209 S.W.3d at 650. In other words, a unilateral contract may now constitute the “otherwise enforceable agreement” in an at-will employment situation.
In particular, if the employer promises to provide confidential information to its employee in the future (in exchange for the promise that it will not be disclosed), an “otherwise enforceable agreement” will be formed once the employer actually provides the confidential information to the employee. The mere fact that the confidential information is not provided at the time the covenant not to compete is entered will not render the covenant unenforceable. Thus, in Sheshunoff, once Johnson was provided with confidential information, his covenant not to compete became effective and enforceable. Nonetheless, the Court emphasized that the employer’s promise remains illusory until it actually provides the confidential information to the employee, as in Light.
The following example is an illustration of the change brought about by Sheshunoff:
Mr. Doe is hired by Acme Corporation as an at-will employee. In conjunction with this employment, Mr. Doe entered into an agreement with the following provision:
During the course of your at-will employment with Acme Corporation, you will receive confidential and trade secret information, including but not limited to client lists, distributor agreements, and Acme price structures. In exchange of your receipt of this information, you will not disclose such confidential and trade secret information and you will not work for any other competitors in the industry.
Two months after entering into this agreement, Mr. Doe becomes an account manager for Acme Corporation and receives the confidential and trade secret information described in the foregoing provision. He then subsequently resigns and is hired by a competitor.
Under Light, the foregoing promise could not amount to an “otherwise enforceable agreement” because “it could not be accepted by future performance, [and thus] could not support a covenant not to compete inasmuch as it was not an “otherwise enforceable agreement at the time the agreement was made’ as required by § 15.50.” The fact that Mr. Doe actually received the confidential and trade secret information is irrelevant. If there is not an otherwise enforceable agreement at the time the covenant is made, it fails to satisfy section 15.50.
Now, under Sheshunoff, the covenant is enforceable against Mr. Doe as soon as he receives the confidential and trade secret information. Hence, in the foregoing example, the covenant not to compete became enforceable against Mr. Doe two months after entering into the agreement (when Mr. Doe received the confidential information). This acceptance by performance may now serve as the “otherwise enforceable agreement” under section 15.50. Nonetheless, until Mr. Doe receives that information, Acme Corporation cannot enforce the covenant not to compete against Mr. Doe. Clearly, this is a much more practical approach to the at-will situation than that taken by the post-Light decisions noted above.
In conclusion, the Sheshunoff court expressed its desire to avert the hyper-technical approaches created by several of the lower courts when following Light:
We also take this opportunity to observe that section 15.50(a) does not ground the enforceability of a covenant not to compete on the overly technical disputes that our opinion in Light seems to have engendered over whether a covenant is ancillary to an otherwise enforceable agreement. Rather, the statute’s core inquiry is whether the covenant “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). Concerns that have driven disputes over whether a covenant is ancillary to an otherwise enforceable agreement-such as the amount of information an employee has received, its importance, its true degree of confidentiality, and the time period over which it is received-are better addressed in determining whether and to what extent a restraint on competition is justified. We did not intend in Light to divert attention from the central focus of section 15.50(a). To the extent our opinion caused such a diversion, we correct it today.
In sum, the Supreme Court clarified that a unilateral contract may constitute an “otherwise enforceable agreement” and serve as the basis for a covenant not to compete so long as the unilateral promise is accepted by performance.
C. The Remnants Of Light
Despite the Court’s decision in Sheshunoff, it seems evident that portions of Light are still good law. Recall, Light focuses on the first element of section 15.50(a) – “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”. First, there must still be an “otherwise enforceable agreement.” To the extent Light precluded unilateral contracts from serving as such an agreement, that portion of the decision was reversed by Sheshunoff. Also, the unilateral contract does not need to consummated at the time the agreement was made. Nevertheless, under Light and Sheshunoff, a promise to provide confidential information in the future will still be illusory so long as the employer fails to provide the confidential information to the employee.
Further, the two-part test for determining “ancillary to or part of” remains untouched. Further, as provided by Light and discussed below, it appears that an employer must still make a definitive promise to provide the at-will employee with confidential information in order for this promise to be considered “ancillary to or part of an otherwise enforceable agreement.”
D. Post- Sheshunoff’s Decision
Since Sheshunoff, there are several cases discussing the Court’s decision. However, the following decisions provide a good idea of how the lower courts have applied Sheshunoff.
In Powerhouse Productions, Inc. v. Scott, 260 S.W.3d 693 (Tex. App.—Dallas 2008, no pet.), the Dallas Court of Appeals recognized that, while Sheshunoff eased the requirements for satisfying the “otherwise enforceable requirement,” the agreement must still be supported by good and valuable consideration. In Powerhouse Productions, Scott was employed by Powerhouse to fly a rocket pack for events around the globe. Id. at 693. During the course of this employment, Scott received confidential information and training concerning the rocket pack and its operation. Id. at 694. After several years of employment, Scott was required to sign an agreement containing a covenant not to compete. The covenant provided that Scott could not work for or consult with any competitor of Powerhouse. The agreement further provided that Scott would not use or disclose Powerhouse’s confidential information. The agreement stated that the consideration for these promises was “the opportunity to become a Pilot of Powerhouse Productions, Inc.” Shortly after entering into this agreement, Scott’s employment with Powerhouse terminated, Scott went to work for a competitor, and litigation ensued over the enforceability of the covenant not to compete. Id. at 695.
On appeal, the Dallas Court of Appeals held that the covenant not to compete was unenforceable for several reasons. The court’s opinion reiterates several valuable lessons from the Court’s decisions in Light and Sheshunoff.
First, in an at-will employment situation, a promise of continued employment, alone, is still illusory and will not be considered an “otherwise enforceable agreement.” Id. at 696-97. Thus, the mere promise to allow Scott to fly the rocket pack was not sufficient consideration.
Second, if an employer intends to argue that providing confidential information to the employee created a unilateral contract, the agreement in question must specifically promise that the employer will provide the employee with confidential information. Id. at 696 n.2 & 698. This promise will not be implied in an agreement, even it is entitled a confidentiality agreement (save the situation described in Beasley v. Hub City Texas, L.P., No. 01-03-00287-CV, 2003 WL 22254692 (Tex. App.—Houston [1st Dist.] Sept. 29, 2003, no pet.), which is discussed below).
Third, even supposing there was such a promise, providing confidential information to the employee in the past is not good consideration. Quoting Sheshunoff, the court acknowledged that the Texas Legislature and the courts “would not allow an employer to spring a non-compete covenant on an existing employee and enforce such a covenant absent new consideration from the employer.” Id. at 697. Thus, when an employer requires an existing employee to enter into a covenant not to compete and promises to provide the employee with confidential information or training, the employee’s past receipt of this information will not render the agreement enforceable. After all, under long standing contract law, past consideration is not competent consideration. Since there was no evidence that Powerhouse provided Scott with confidential information after he signed the agreement, any promise to provide such information remained illusory under Sheshunoff.
Finally, the court recognized that, while the Supreme Court recently indicated that the lower courts should shy away from technical disputes concerning the “ancillary to or part of an otherwise enforceable agreement” requirement, consideration was still an essential requirement under section 15.50(a). Id. at 699. Since there was no consideration to support the agreement containing the covenant not to compete, the court held there was not an “otherwise enforceable agreement,” and therefore, the covenant not to compete was unenforceable.
Another post-Sheshunoff case is Hardy v. Mann Frankfort Stein & Lipp Advisors, Inc., 263 S.W.3d 232 (Tex. App.—Houston [1st Dist.] 2007, pet. granted). In that case, Fielding and Hardy, two accountants, worked for Mann Frankfort. Id. at 239. When Fielding was initially hired, he entered into an agreement whereby he promised not to disclose confidential information, but the agreement did not explicitly provide that he would receive confidential information or have access to such information. Hardy likewise entered into an employment agreement wherein he acknowledged he would have access to the firm’s clients. Also, the agreement stated that Hardy would not “during or after the period of active employment, disclose ” proprietary information of [his employer] such as financial records, data, programs, etc.” He further agreed that he would neither call nor solicit, either for himself or for any other Person any of the clients of the firm for a period of twenty-four (24) months immediately following [his] period of active employment.” However, if he did, the agreement provided that he would have to pay a portion of the fees generated from these clients to his employer.
Thereafter, both Fielding and Hardy entered into limited partnership agreements with Mann Frankfort. Id. at 240. While these agreements provided that neither Fielding nor Hardy would disclose Mann Frankfort’s confidential and trade secret information, the agreements did not promise to disclose confidential information or allow Fielding or Hardy to gain access to information.
Several years after entering into these agreements, Fielding and Hardy created their own accounting firm and sought to have their covenants not to compete declared unenforceable. The trial court agreed and declared the agreements unenforceable.
On appeal, the Houston First Court of Appeals examined the enforceability of the covenants not to compete in light of both Sheshunoff and Light. Id. at 244. The Court found that, as in Light, the covenants in the limited partnership agreement failed to meet the “ancillary to” test because neither agreement contained a promise to provide confidential information. Id. at 245.
As for Fielding’s initial employment agreement, Mann Frankfort argued that Beasley v. Hub City Texas, L.P. supports the proposition that an implied promise is sufficient consideration to support a covenant not to compete. Id. at 246-47 (citing No. 01-03-00287-CV, 2003 WL 22254692 (Tex. App.—Houston [1st Dist.] Sept. 29, 2003, no pet.)). Yet, the Hardy court quickly distinguished Beasley from its case. In Beasley, the employee signed an agreement containing an acknowledgement that, by virtue of his employment, he would be granted otherwise prohibited access to confidential and proprietary data of the employer. The Hardy court recognized that it “ha[d] previously treated an employee’s acknowledgment that he has or will receive trade secrets and confidential information from his employer as an implied promise that the employer will provide trade secrets and confidential information.” The Hardy court even affirmed that its holding in Beasley was consistent with the Supreme Court’s holding in Sheshunoff. However, in its case, there was no acknowledgement by Fielding that he would receive confidential information. Thus, the court refused to imply such a promise and found that the covenant was not “ancillary to or part of an otherwise enforceable agreement.”
The court also found that Hardy’s covenant not to compete met Sheshunoff but that the covenant was overly broad because its pricing requirement was too restrictive and the covenant prohibited Hardy from contacting clients that he did not personally serve. Because the accounting firm sought only damages, the covenant was not susceptible to reformation and was unenforceable.
Despite the holdings in Powerhouse and Hardy, where the Houston and Dallas Courts of Appeals refused to imply a promise to provide confidential information, the Corpus Christi Court of Appeal effectively enforced such an implicit promise by enforcing a covenant not to compete. In Shoreline Gas, Inc. v. McGaughey, No. 13-07-364-CV, 2008 WL 1747624 (Tex. App.—Corpus Christi Apr. 17, 2008, no pet.), McGaughey was hired by Shoreline in 2002 as a gas supply representative. Id. at *1. McGaughey was an at-will employee. As a condition of his employment, McGaughey was required to sign an employment agreement, which contained a covenant not to compete and non-disclosure agreement. After terminating McGaughey, Shoreline filed an application for temporary injunction and request for declaratory judgment seeking for enforcement of the covenant not to compete. However, the trial court refused the temporary injunction. Id. at *1-2.
On appeal, the Corpus Christi focused on whether there was a probable right of recovery, i.e. whether there was an enforceable covenant not to compete. After a lengthy discussion of both Light and Sheshunoff, the Shoreline court claimed that the agreement in question resembled that in Sheshunoff. The court stated:
As in Sheshunoff, the employment relationship here was at-will, and the employee promised not to disclose the employer’s confidential information. McGaughey’s promise not to disclose Shoreline’s confidential information, though not enforceable when made, constituted an offer for a unilateral contract which Shoreline had the option to accept. Shoreline accepted McGaughey’s offer by performing — that is, by supplying McGaughey with confidential information — and so a unilateral contract was formed under which McGaughey became bound by his promise not to disclose that information. Under Sheshunoff, such a unilateral contract constitutes an “otherwise enforceable agreement” sufficient to support an accompanying non-compete covenant.
Id. at *6 (emphasis added, citations omitted). In its opinion, the court makes no mention of a