Deconstructing Texas’ Covenants Not to Compete Act

Texas’ Covenants Not to Compete Act (“the Act”) has been in existence for over 30 years. During the first half of its existence, the Act was interpreted in a manner that made it extremely difficult for an employer to establish adequate consideration. This changed following a series of Texas Supreme Court opinions beginning in 2006, which significantly expanded the requisite consideration that may support an enforceable noncompete covenant.

In the wake of this precedent, the battleground for present-day noncompete litigation rarely centers on whether the covenant is supported by adequate consideration. Instead, disputes over enforceability most often now hinge on reasonableness—whether the covenant is narrowly tailored and no greater than necessary to support an employer’s legitimate business interests. And, because the Act requires courts to reform noncompete covenants that are otherwise overbroad, it is now significantly harder to defeat such covenants in their entirety.

Nevertheless, there remains a minefield of issues that can drastically impact the enforcement of such covenants. This article highlights several key issues that practitioners should be mindful of under the Act (there are also additional considerations for covenants involving licensed physicians, which are outside the scope of this article).

1. The Act Applies to All Restrictive Covenants (Not Just Noncompetes)

The Act technically does not restrict an employer’s ability to implement restrictive covenants. To the contrary, it creates an exception. Restraints on trade, including restraints on professional mobility, are per se unlawful under the Texas Free Enterprise and Antitrust Act unless they meet the requirements of the Act. Importantly, courts recognize that nonsolicitation covenants also constitute restraints on trade—meaning they too are subject to the Act and the same analysis as noncompete covenants.

2. The Act Requires Specific Consideration

In order for a restrictive covenant to be enforceable under the Act, it must be (1) ancillary to or part of an otherwise enforceable agreement at the time the agreement is made; and (2) reasonable, and not impose a greater restraint than necessary to protect the goodwill or other business interest of the employer. For a restrictive covenant to be ancillary to or part of an otherwise enforceable agreement, the consideration from the employer must give rise to the employer’s interest in restraining the employee. Business goodwill, confidential or proprietary information, trade secrets, specialized training and equity are interests that can be, in appropriate circumstances, worthy of protection. Conversely, pay raises and bonuses are insufficient because the mere payment of money has no relation to a legitimate business interest the employer is trying to protect. Stated differently, restrictive covenants cannot be bought in Texas.

While this consideration does not need to be provided contemporaneously with the execution of the restrictive covenant, an employer must provide new consideration post-execution (past consideration is no consideration). As a practical result, this will never happen in connection with a severance agreement because the employee will never receive new confidential information, new goodwill, etc. (and, again, money is insufficient consideration under the Act).

3. Reformation is a Double-Edged Sword Under the Act

In order for a restrictive covenant to be reasonable, it must generally be narrowly tailored in time, scope and geographic area, such that it is no greater than necessary to protect the employer’s legitimate business interests. In instances where a restrictive covenant is overly broad, courts are generally required to reform the covenant (rather than refuse to enforce it). Many employers mistakenly interpret this backstop as a reason to err on the side of implementing overly broad restrictive covenants.

However, there are two reasons why an employer should attempt to make the covenants narrowly tailored from inception. First, the Act allows an employee to recover attorneys’ fees from an employer who knowingly enforces a restrictive covenant to a greater extent that was necessary to protect its legitimate business interests. Second, the Act bars an employer from recovering any damages for a pre-reformation breach of a restrictive covenant.

In other words, in instances where a restrictive covenant is broad as is, an employer’s only recourse is injunctive relief—it would not have a viable claim for damages until after the court reforms (which will often be mooted after injunctive relief is issued because an employee is unlikely to violate a court order). Conversely, if reformation is unnecessary to enforce the covenant, then the employer would have the ability to recover all economic damages. This distinction can have significant ramifications in cases where monetary damages are a key issue.

4. The Act Generally Preempts the Recovery of Attorneys’ Fees

The Act also expressly preempts enforceability criteria and remedies that are otherwise provided by common law or contract. Because the Act only provides for an award of attorneys’ fees in a single circumstance (where an employer knowingly enforces a restrictive covenant to a greater extent than necessary) courts have interpreted the Act as preempting attorneys’ fees in all other instances—regardless of whether the employer is the prevailing party. This includes the preemption of attorneys’ fees under Chapter 38 of the Texas Civil Practice and Remedies Code, and attorneys’ fees provided by contract.

Mark A. Shank is a senior counsel at Diamond McCarthy, where he focuses his practice on commercial litigation, employment disputes and arbitration matters. He is the author of the Texas Litigators’ Guide to Departing Employee Cases.

Jason T. Weber is a shareholder in the Dallas office at Polsinelli, where he focuses his practice on business disputes and employment-related consulting and litigation.