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1. The Night the Light Went Out in Texas:What Employers Now Need to Know about Enforcing and Defending Texas NoncompetesCorporate Counsel Series Strasburger & Price, LLP www.strasburger.com

2. Summary • Background on Noncompete Agreements in Texas and Case Law • Practical Tips: Drafting the Enforceable Noncompete • Practical Tips: Challenging a Noncompete

3. Background: Noncompetes • In Texas, noncompetes are seen as restraints on trade that are generally not enforceable. • One reason is because of the strict requirements governing noncompetes in Texas under Texas Business and Commerce Code §15.50. • However, the Texas Supreme Court recently made the requirements more flexible and made noncompetes more likely to be enforced.

4. Background: The Statute • Under Tex. Bus. & Comm. Code § 15.50(a): • A noncompete is enforceable if: • it is ancillary to or part of an otherwise enforceableagreement at the time the agreement is made; [and] • to the extent that it 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.

5. Background: What does that mean? • The consideration for the noncompete must be tied to the employer’s reason for requesting the noncompete, such as providing: • the employer’s confidential information and trade secrets; or • specialized training.

6. Background: Light v. Centel • Light v. Centel Cellular Co. of Texas, 883 S.W.2d 642 (Tex. 1994), the leading Texas noncompete case for the past 12 years. • Many of its principles still apply. • In 1985, Debbie Light was hired as an at-will employee to sell pagers. In 1987, she was required to sign a noncompete to begin selling cellular products. Ms. Light resigned in May of 1988, and sued challenging the enforceability of the noncompete. • The Texas Supreme Court held : • an at-will employment relationship can support an ‘otherwise enforceable agreement’ so long as the duration of employment does not make the consideration illusory. • The consideration given by the employer must ‘give rise’ to reason to restrain trade. • The Employee must make a reciprocal or return promise designed to support the covenant. • The noncompete was not enforceable because Ms. Light did not promise not to disclose Centel’s confidential or proprietary information.

7. Background: Light’s Footnote 6 • In FN 6 of Light, the Texas Supreme Court analyzed unilateral contracts – which is at the crux of the noncompete controversy • “For example, suppose 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 illusorybecause the employer could fire the employee and escape the obligation to perform… • 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.”

8. Background: Light’s Progeny • Thus, under FN 6 of Light, a unilateral contract was not an otherwise enforceable agreement at the time the agreement was made because the employer was not obligated to perform its promise. • FN 6 was the subject of much litigation for the next twelve years. • There was also a split among the Texas Court of Appeals in analyzing noncompete agreements. • Some Courts applied Lightstrictly -- The employer must promise and perform immediately (i.e. simultaneous mutual exchange of the noncompete and the confidential information). • Others applied a “light” version of Light– Mutual bilateral promises are sufficient (i.e. upholding agreements where the employer “shall” provide confidential information).

9. The Texas Appellate Split

10. Background: Litigating Light • Therefore in most jurisdictions in Texas (unless the company had a picture of the employee signing the noncompete and receiving the confidential information), most noncompetes did not satisfy the first requirement of Section 15.50(a) and were not enforceable. • In October 2006, the Texas Supreme Court revisited Light in reviewing a case that had been decided by the Austin Court of Appeals in 2003.

11. Alex Sheshunoff Mgmt. Servs., L.P. v. Johnson, 209 S.W.3d 644 (Tex. Oct. 20, 2006) • Kenneth Johnson had been an at-will employee of Alex Sheshunoff Management Services (ASM) since 1993. • In 1997, ASM promoted Johnson to a new position, and shortly after his promotion presented him with an employment agreement that included a noncompete. • ASM promised to give Johnson notice of any forthcoming termination, specialized training, and “access” to confidential information. ASM required Johnson to sign the agreement as a condition of continued employment. • The agreement prohibited Johnson from providing consulting services to any ASM clients with whom Johnson had performed significant work and prohibited Johnson from directly or indirectly soliciting current or prospective clients of ASM. • In 2002, Johnson left to go work for one of ASM’s competitors. ASM sued Johnson under the agreement.

12. Sheshunoff: Initially on the Light Path • Johnson and his new employer obtained summary judgment -- the agreement was unenforceable under Light’s FN 6 as the promises to provide confidential information and training were illusory. • The Austin Court of Appeals agreed. The key time frame for analyzing the agreement “is the moment the agreement is made” -- since ASM provided the new confidential information after the agreement was signed, the promise was illusory at the time of the agreement and unenforceable. • The Texas Supreme Court heard oral arguments on November 10, 2004.

13. Sheshunoff: The Departure From Light • The Supreme Court agreed that under then-current law, the agreement was not enforceable at the time it was made. Under Light, the district court was correct because “ASM could fire Johnson after the agreement was signed, and before it provided any confidential information or specialized training, ... the agreement ... did not oblige ASM to provide initial training whether or not Johnson was still employed by ASM.” • However, the Court held that it was departing from Light – FN 6. • The Court revisited the meaning of the phrase “at the time the agreement is made” and examined the legislative history behind Section 15.50.

14. Sheshunoff: The Departure From Light • “At the time the agreement is made” provision can modify either: (1) “otherwise enforceable agreement” or (2) “ancillary to or part of.” • Light had held that it modified No. 1. • The Sheshunoff Court observed that a noncompete need only be “ancillary to or part of” the agreement when the agreement is made. • Holding: A covenant not to compete is not unenforceable under Section 15.50(a) solely because the employer's promise is executory when made. If the employer later performs on his promise to provide confidential information, a unilateral contract is formed, and the noncompete is enforceable so long as the other requirements of Section 15.50(a) are met.

15. The Sheshunoff Shift: Focus on Time, Scope and Geography • Page 655: “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…” • 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. • No more concerns over whether a covenant is ancillary to an otherwise enforceable agreement. • “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.”

16. Sheshunoff : What does it mean? • There is no requirement of contemporaneous exchange at the time the noncompete is made. • Employer must promise in the agreement to provide confidential information or training (during the period of employment). • Employer must provide the confidential information or training. • Justice Jefferson indicates that employers should beware of the “last minute agreement” (i.e. providing confidential information on the eve of an employee’s termination for the purpose of making the noncompete binding). • There must be a return promise by the employee to keep the information confidential.

17. Part II: Drafting the Enforceable Noncompete

18. Sheshunoff makes it EASY to draft enforceable noncompetes, right? RIGHT? • Typical lawyer response = IT DEPENDS • Post-Sheshunoff noncompetes still require: • justification for a noncompete • properly-drafted promises • reasonable restrictions • evidence supporting consideration

19. Sheshunoff: What To Expect • Post-Sheshunoff noncompete analysis = more fact specific • DO NOT rely on generic noncompete forms

20. Practical Tip: Do not use a form noncompete.

21. Do you need a noncompete? • The Sheshunoff Court indicated that courts may determine “whether and to what extent a restraint on competition is justified” by the amount of information an employee has received, its importance, its true degree of confidentiality, and the time period over which it is received. • Maybe employers don’t need a noncompete for every employee position. • Nondisclosure covenant may suffice.

22. Noncompete promises checklist: a. ancillary to or part of an otherwise enforceable agreement b. consideration must “give rise” to a reason to restrain trade c. a reciprocal promise by employee OR, stated another way … • Employer promises to provide confidential information/ specialized training to the employee who acknowledges the confidential/specialized nature of the information and promises not to disclose it.

23. What about other promises? • NO promises to give pre-termination notice. • NO promises to give money, either pre or post employment. • NO promises to arbitrate disputes or provide references. • ONLY a promise to provide something that the employer would not want its competitors to know AND a return promise by the employee to keep it confidential.

24. DID THE EMPLOYER “PROMISE” TO GIVE SUFFICIENT CONSIDERATION? • 1. “Employee acknowledges the confidential and proprietary nature of the Information and shall not disclose the Information.” NO – Employer did not promise anything. • 2. “Employee acknowledges that she may receive confidential information during her employment and agrees to keep such information confidential.” “Employee agrees that he may have access to Employer’s Confidential Information. In consideration thereof, Employee agrees to maintain the confidentiality of Employer’s Confidential Information.” PROBABLY NOT - Employer did not promise anything and employee only acknowledged possible receipt of, or access to, information from some unnamed source. But, there is arguably an implied promise to provide information.

25. 3. “In order to perform the functions of his/her position, Employee will have access to certain confidential and proprietary information of Employer, including but not limited to …. “ UNCERTAIN - Employer did not specifically promise to actually provide confidential information. However, the language affirmatively states that Employee will have (not “may have”) access to the information. At this time, post-Sheshunoff courts may find such language enforceable IF proof of actual receipt of information exists. • 4. “Company will grant Employee access to the Confidential Information….” MOST LIKELY YES – Employer is, arguably, affirmatively obligating itself to make the confidential information available. Enforceability will still be very dependent on whether confidential information was actually provided.

26. 5. “During the Term, Employer promises to provide Confidential Information to Employee. Employee agrees to maintain the confidentiality of the Confidential Information and not disclose it ….” YES - Employer is affirmatively obligating itself to provide confidential information. While Sheshunoff requires proof that such information was provided, there should not be any argument as to whether the promise was to simply make such information “available” or “accessible.”

27. Be reasonable!!Post-Sheshunoff courts will likely focus more on time, scope and geography, so be prepared to defend your decisions. Time: 1 – 2 years = Probably OK, but 3 years is pushing it …. • consider noncompete periods commensurate with tenure. • consider noncompete periods commensurate with severance payments.

28. Scope/Geography: Employee’s actual client contacts or area of responsibility. • avoid prohibiting contact with any/all company clients. • don’t claim a nationwide area of responsibility just because the company has nationwide operations; instead, focus on where the employee actually worked or had oversight. • evidence = employee performance reviews, job descriptions, emails.

29. REASONABLE OR UNREASONABLE? • 1. “Employee agrees that, for the Noncompete Term, he will not, for himself or others, directly or indirectly solicit, engage or otherwise provide services for any Company Client.” PROBLEM – Assuming a reasonable time period, nothing suggests that “Company Clients” is defined as only those clients for whom Employee provided services. Moreover, “services” is too broad and should be limited to the services Employee provided for the Company.

30. 2. “Employee shall not, for a period of eighteen (18) months following the Termination Date, directly or indirectly engage in the Company Business for himself or for the benefit of any other person or entity, provided that Employee may do so with the prior, written consent of the Company, which shall not be unreasonably withheld.” PROBLEM – Although eighteen months is probably a reasonable time period, nothing suggests that “Company Business” is restricted to the services Employee provided for the Company or to the business that Employee provided for specific Company clients. The “prior written consent” language simply creates more grounds for litigation.

31. 3. “Following termination of employment, Employee, for himself or others, shall not, without Employer’s prior written consent, provide direct or indirect services to any customer of Employer with whom Employee, or Employee’s subordinates, had direct contact during the twelve months preceding Employee’s termination.” PROBLEM – Although the prohibitions’ scope is more specific to the Employee’s actual contacts (but the subordinates’ contacts may be a stretch), there is no stated duration for the noncompete.

32. 4. “For twenty-four months following the termination date, Employee shall not, directly or indirectly for himself or others, provide the Services for any actual or prospective clients of the Company whose primary business operations are located in Harris County, Texas.” PROBLEM – A two-year period is normally reasonable. Assuming “Services” is not overly broad, and the prohibition is limited to a very specific geography. But “prospective clients” and “primary business operations” are very open-ended terms, and they do not address Employee’s involvement with such Company clients.

33. Evidence of “consideration” a/k/a the confidential information. • Post-Sheshunoff noncompetes do not require evidence of simultaneous exchange of consideration. BUT employers still need to prove consideration was received by the employee. • DOCUMENT, DOCUMENT, DOCUMENT! • employee’s written acknowledgement of receipt of information • document in employee file • email confirming provision/receipt of information • performance review documentation referencing information used by employee

34. PART III: Challenging A Noncompete

35. THE OTHER SIDE • You want to hire that dream candidate but you are concerned about the noncompete or nonsolicitation agreement the candidate signed with her prior employer. What do you look for? Can it still be challenged post-Sheshunoff? • Checklist: 1. Was the agreement ancillary to or part of an otherwise enforceable agreement? 2. Did the consideration “give rise” to a reason to restrain trade? 3. Was there reciprocal promise by the employee? 4. Is it reasonable in terms of time, scope and geographic limitation? 5. Was new confidential information provided to the employee during her employment?

36. Sheshunoff – The Challenge Specifics: 1. Does the agreement contain a promise/agreement to provide confidential information? • Sheshunoff does not overturn the portion of Light regarding the agreement to provide confidential information. The Sheshunoff Court seized on the word “promise” and uses it numerous times. If there is no promise – argue no promise. However, Sheshunoff was an “access to” case so actual application may be broader. • Example: Employee acknowledges that company’s customer lists, marketing materials and other information provided by the company are confidential and he/she agrees not to use and disclose such information. • This is an example of nondisclosure covenant but does not require or even imply that the Employer promises to provide the employee with the confidential information. Thus it would not be sufficient under Sheshunoff.

37. Sheshunoff – The Challenge 2. Remember, money – no matter how much – is not sufficient consideration for a noncompete. This is the old American Fracmaster case. Likewise, stock options are likely insufficient. They can be used as consideration for a contract but not a noncompete. • Example: The employer paid $180,000.00 in a severance agreement. Noncompetes in severance agreements are almost always unenforceable because the consideration does not “give rise” to a reason to restrain trade. Therefore, if money is the statedreason for the noncompete, there is good basis for a challenge to the consideration. • Example: In consideration for the severance payment of $300,000.00 over the next two years, employee agrees he will not compete with company in any capacity, directly or indirectly with any business which is in competition with company.

38. Sheshunoff – The Challenge 3. Is there a return promise by the Employee not to use or disclose the confidential information? • This was the reason in Light why the Court held the noncompete unenforceable. 4. Is the covenant reasonable in terms of time? • Generally that means 1-2 years. It can be longer especially in a sale of business case.

39. Sheshunoff – The Challenge 5. Is the covenant reasonable in terms of scope and geographic restriction? • An area of possible leverage. • Sheshunoff held that courts should focus on this area. A noncompete which contains an industry-wide exclusion or which extends to clients with whom a salesman had no dealings during his employment is overly broad. See, Peat Markwick Main & Co., 818 S.W.2d 381, 387 (Tex. 1991), John R. Ray & Sons, Inc. v. Stroman, 923 S.W.2d 80, 85 (Tex. App.—Houston [14th Dist.] 1996, writ denied). • In a post-Sheshunoff case, a court of appeals held a noncompete unenforceable because it was overly broad. The noncompete attempted to extend to clients with whom the employee had no dealings during his employment. See Hardy & Fielding v. Mann Frankfort Stein & Lipp Advisors, Inc. No. 01-05-0108-CV, 2007 Lexis 3442 (Tex. App.—Houston [1st Dist] May 1, 2007, no pet).

40. Sheshunoff – The Challenge 6. Did the employee received confidential information. For example, in DeSantis v. Wackenhut, 793 S.W.2d 670: “ Wackenhut also claims that it possessed confidential information protected by an agreement not to compete. Specifically, Wackenhut contends that during his employ, DeSantis learned the identity of Wackenhut’s customers, their special needs and requirements, and Wackenhut’s pricing policies, cost factors and bidding strategies. Again, while confidential information may be protected by an agreement not to compete, Wackenhut has failed to show that it needed such protection in this case. Wackenhut failed to show that its customers could not readily be identified by someone outside its employ, that such knowledge carried some competitive advantage, or that its customers’ needs could not be ascertained simply by inquiry addressed to those customers themselves. Also, Wackenhut failed to show that its pricing policies and bidding strategies were uniquely developed, or that information about its prices and bids could not, again, be obtained from the customers themselves.”

41. Sheshunoff – The Challenge • 7. Past consideration is generally not good consideration. • CRC Evans Pipelilne Int’l, Inc. v. Myers, 927 S.W.2d 259, 265 (Tex. App.—Houston [1st Dist.] 1996, no writ).

42. Questions