Supreme Court Favors Employer over Employee

In a recent opinion, the Texas Supreme Court ruled in favor of an employer which was trying to prevent a former employer from working for a competitor.

The case was Marsh USA, Inc. v. Cook, ___ S.W.3d ___ (Tex. 2011)(6/24/11). In it, when an executive exercised stock options, he was required to sign a covenant not to compete. The supreme court ruled that the agreement was enforceable to protect the “goodwill” of the company. The “consideration for the noncompete agreement (stock options) is reasonably related to the company’s interest in protecting its goodwill, a business interest the Act recognizes as worthy of protection.”

“The Texas Constitution protects the freedom to contract. Entering a noncompete is a matter of consent; it is a voluntary act for both parties. However, the Legislature may impose reasonable restrictions on the freedom to contract consistent with public policy. It has done so with . . . Tex. Bus. & Com. Code 15.50-.52” “‘A person’s right to use his own labor in any lawful employment is . . . one of the first and highest of civil rights.'” This is “protected by sections 15.05 and 15.50(a) . . . and is not offended by enforcing covenants not to compete that comply with section 15.50(a).”

“The purpose of Chapter 15 is ‘to maintain and promote economic competition in trade and commerce’ . . . [and] [u]nreasonable limitations on employees’ abilities to change employers or solicit clients . . . could hinder legitimate competition. . . .” But “valid noncompetes constitute reasonable restraints on commerce agreed to by the parties and may increase efficiency in industry by encouraging employers to entrust confidential information and important client relationships to key employees.” They “also incentivize employers to develop goodwill by making them less reluctant to invest significant resources in developing goodwill that an employee could otherwise immediately take and use against them in business.”

The Act was “crafted . . . to prohibit naked restrictions on employee mobility” while allowing “reasonable restrictions . . . that are ancillary to or part of a valid contract . . . unrelated to restraining competition. . . .” Section “15.05(a) . . . [is] a policy limitation on the freedom between employers and employees to contract . . . ‘in restraint of trade’ . . . [when the purpose] ‘is merely to restrain competition. . . .'” The covenant must be “ancillary to a valid contract” the “primary purpose” of which “is unrelated to restraining competition.”

If ancillary to an otherwise enforceable agreement, a “noncompetition agreement is enforceable if it is reasonable in time, scope and geography. . . .” Reasonable non-competes are not contrary to public policy as a restraint of trade. There is a two-step analysis: first, is the agreement to which it is ancillary enforceable, and second, is the covenant not to compete ancillary to or part of the agreement. The first “is satisfied when the covenant is ‘part of an agreement that contained mutual non-illusory promises.'” Here the issue is the second requirement: is it “‘ancillary to or part of’ the otherwise enforceable agreement.” The test looks at whether the transaction “‘gives rise to an interest worthy of protection.'” Goodwill, trade secrets, and confidential information are “protectable business interest[s].”

“The hallmark of enforcement is whether or not the covenant is reasonable.” Here, the employee’s “exercise of the stock options to purchase MMC stock at a discounted price provided a reasonable nexus between the noncompete and the company’s interest in protecting its goodwill.” “There is no requirement . . . that the employee receive consideration for the noncompete agreement prior to the time the employer’s interest in protecting its goodwill arises.”

The bottom line: if the employer requires the employee to sign a noncompete when he exercises the stock options he earned, he is restricted from working elsewhere.