The New Business Reality of Enforcing Non-Compete Covenants Under Texas Law

By Charles M.R. Vethan, Esq.

Consider this all too common scenario for a new business owner:  before becoming an entrepreneur, you were a senior employee at an established business.  You decided, however, that you could make more money and could better service your customers by setting up your own business.  Now, a few days after you started your new business, you receive an ominous letter from your former employer’s business litigation counsel advising you to refrain from using the business trade secrets of your former employer, and reminding you that you signed a non-compete agreement.  The letter ends in a flourish stating that unless you immediately cease and desist competing with your previous employer, you will be sued, and be subject to an injunction, preventing you from competing with your former employer.  After the initial shock of the letter wears off, you, like many other business owners, must consider whether the non-compete agreement is enforceable, and whether your previous employer may stop you from working.

            The answer, of course, is that it depends on how the non-compete agreement was obtained by your previous employer, and the terms of that agreement.  The basic rule is that such an agreement, referred to as a covenant not to compete, must satisfy Texas’ minimum statutory criteria in the Texas Business and Commerce Code, the statute governing the enforceability of covenants not to compete.  The Business and Commerce Code requires that  (1) the non-compete covenant must be “ancillary to an otherwise enforceable agreement” and (2) the non-compete covenant, even if valid, must contain reasonable “limitations as to time, geographical area, and scope of activity” to be restrained.   This arises with “at will” employees – employees who are not under a formal contract of employment, for a set period, and with additional conditions of employment.

            The law will enforce a covenant not to compete signed by an employee, if that covenant is not merely a naked restraint of trade, but seeks to protect a valid business interest.  Texas courts have routinely held that trade secrets, such as confidential client lists, contact information, confidential marketing strategies, and product and process methods, are valid business interests meriting protection under the law.  If such trade secrets provide a business with a commercial advantage over its competitors, Texas law will recognize a proprietary interest in that information.

To enforce a non-compete covenant, a business must show that the covenant is “ancillary to or part of an otherwise enforceable agreement.” The covenant not to compete must also be shown to be reasonable in time and scope, and cannot be any more restrictive than necessary to protect the employer’s valid business interests.   The enforceability of a covenant not to compete is a question of law for the trial court, which means a judge, not a jury, determines its enforceability.

Texas law requires a business to show that non-illusory consideration was given to support the covenant not to compete. For example, an at-will employment relationship is not an otherwise enforceable agreement, as a promise of continued employment where the employer retains the unrestrained right to fire the employee is an illusory (non-binding) promise. Any other agreement entered into during the course of employment would have to be supported by non-illusory consideration in order to constitute an “otherwise enforceable agreement” under Texas law, and would itself have to give rise to an interest worthy of protection in order to support a covenant not to compete.   However, if the employer promises to provide trade secrets and other confidential information to the employee, necessary for the employee to perform his or her duties, even an at will employee may be bound by the covenant not to compete.

            The battle lines for most contemporary businesses are drawn here, when employees are promised that they will be provided with confidential trade secrets of the business in exchange for signing a covenant not to compete.  However, it seems rather unfair for an employee to sign a covenant not to compete upon commencing his or her employment, supported only with a promise that the business will provide some nebulous confidential information in the future.  This is a unilateral contract, where the employee performs immediately, by signing the covenant not to compete, but the employer merely gives a promise of future performance.  Until recently, Texas courts required such confidential information to be exchanged contemporaneously with the employee signing the covenant.  As a practical matter, a business does not typically provide all its trade secrets and confidential information to a new employee at the time a covenant not to compete was signed.

            A recent Texas Supreme Court decision recognized this fact and modified the longstanding rule in Texas with respect to when and what an employer must give in consideration to bind an employee to a non-compete agreement.  In Sheshunoff Management Services v. Johnson, the Texas Supreme Court held that a promise to provide an employee with confidential information will be deemed to be sufficient consideration, if the employer does, in fact, provide some confidential information during the employment relationship.  In Sheshunoff, the employee agreement stated that the employer would assist the employee in the performance of his / her duties, and that the employer agreed to provide the employee special training regarding employer’s business methods and access to certain confidential and proprietary information and materials belonging to employer.   The departure of Sheshunoff from the previous Texas rule is that under the new legal environment, all an employer must show is that at some point during the employment relationship, the business did provide some confidential trade secret information to the employee.   The Sheshunoff Court reasoned that “the fatal defect in the agreement in Light was not that it was unenforceable when made, but that there was no ‘ancillary’ promise by the employee . . . to not disclose confidential information, that the covenant not to compete was designed to enforce.”   The Texas Supreme Court in Sheshunoff  held that “a unilateral contract formed when the employer performs a promise that

was illusory when made can satisfy the requirement of the Act.”   In other words, the business promises to provide trade secrets and confidential information to the employee at some point in the future, in exchange for the employee immediately signing a non-compete agreement.  This is a unilateral contract as the employee must perform now, but the employer is not required to immediately keep its end of the bargain.  Once performance occurs by the business – by providing some trade secrets and confidential information – the non-compete signed by the employee is deemed enforceable.  The Texas Supreme Court further noted that “there is no sound reason why a unilateral contract made enforceable by performance should fail under the Act.”

            While the rules are different if a business seeks to have existing employees sign a non-compete agreement, Sheshunoff does not disturb the holding in Light for those categories of employees.  Simply stated, a business must provide additional consideration, separate and apart from an existing employee’s salary, to support a covenant not to compete.  “A covenant cannot be a stand-alone promise from the employee lacking any new consideration from the employer. Whether a specific non-compete agreement is enforceable is driven on a case-by-case basis.  The agreement must be analyzed by counsel to determine whether the proposed covenant not to compete is an illegal naked restraint of trade, or whether it is ancillary to an otherwise enforceable agreement, worthy of protection by Texas court.

            The statements in this article are not legal opinions, but are intended to provide you with some background information in this very dynamic area of business law in Texas.  Businesses or employees evaluating a non-compete agreement should consult with a qualified business attorney. At The Vethan Law Firm, PC, our business and corporate attorneys work with businesses and entrepreneurs to review and analyze non-compete covenants, so that our clients are informed as to realistic legal options available when considering to implement or terminate such covenants.

Tex. Bus. & Com. Code § 15.50.
Tex.Bus. & Com.Code § 15.50 (Vernon Supp.1994).
Light v. Centel Cellular Co., 883 S.W.2d 642, 644 (Tex.,1994); Martin v. Credit Protection Ass'n, Inc., 793 S.W.2d 667, 668­69 (Tex.1990).
Light, 883 S.W.2d at 645, n.6 ( Tex. 1994).; DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 682 (Tex. 1990).
Travel Masters Inc. v. Star Tours, Inc., 827 S.W.2d 830, 832­33 (Tex.1991).
Light at 647; DeSantis at 682; Ireland v. Franklin, 950 S.W.2d 155, 158 (Tex.App.­San Antonio 1997, no writ).
Sheshunoff Management Services v. Johnson, 209 S.w.3d 644, 647 (Tex. 2006).
209 S.W.3d at 650.
Sheshunoff Management Services v. Johnson, 209 S.w.3d 644, 651 (Tex. 2006).
Martin v. Creditg Prot. Ass'n, Inc., 793 S.W.2d 667, 669 (Tex. 1990).
Tex. Bus. & Com. Code § 15.50.
Tex.Bus. & Com.Code § 15.50 (Vernon Supp.1994).
Light v. Centel Cellular Co., 883 S.W.2d 642, 644 (Tex.,1994); Martin v. Credit Protection Ass'n, Inc., 793 S.W.2d 667, 668‑69 (Tex.1990). Light, 883 S.W.2d at 645, n.6 ( Tex. 1994).;  DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 682 (Tex. 1990).
Travel Masters Inc. v. Star Tours, Inc., 827 S.W.2d 830, 832‑33 (Tex.1991).
Light at 647; DeSantis at 682; Ireland v. Franklin, 950 S.W.2d 155, 158 (Tex.App.‑San Antonio 1997, no writ).
Sheshunoff Management Services v. Johnson, 209 S.w.3d 644, 647 (Tex. 2006).
In Light, the Supreme Court raised a concern that an employer could secure the non-compete with a promise to provide confidential information, but fire the employee before such information was actually provided, thus creating an illusory contract.  The Court in Light held that such a unilateral contract could not be deemed as an otherwise enforceable agreement.  The Sheshunoff Court departed from this holding.  See Sheshunoff, 209 S.W.3d at 650.
209 S.W.3d at 651.
209 S.W.3d at 650.
Sheshunoff Management Services v. Johnson, 209 S.w.3d 644, 651 (Tex. 2006).
Martin v. Creditg Prot. Ass’n, Inc., 793 S.W.2d 667, 669 (Tex. 1990).