We are blogging on “Non-competes, Trade Secrets, Fiduciary Duties, and the Inevitable Disclosure Doctrine.” Mark Oberti has prepared a detailed paper on all of these issues, which can be found here.
Stock Options Recognized As Sufficient To Support A Noncompetition Agreement
In 2011, the Texas Supreme Court held that stock options given in consideration for a noncompete agreement were reasonably related to the employer’s interest in protecting its goodwill and could support a noncompetition agreement. Marsh USA Inc. v. Cook, 354 S.W.3d 764, 774-76 (Tex. 2011). Texas Supreme Court rejected language from its decision in Light by holding that consideration for a covenant not to compete need not “give rise” to the employer’s interest in restraining the employee from competing. Id. In doing so, the court ruled by a 6-3 majority that stock options granted to a valuable employee are sufficient consideration to support a post-employment restrictive covenant because they are “reasonably related” to the company’s interest in protecting its goodwill. As it did in its Sheshunoff decision in 2006, the court again sent a strong signal to lower courts that in analyzing noncompetition agreements, the primary focus is whether or not the covenant is reasonable, not whether the agreement passes muster under a highly technical analysis not contemplated by the Texas Legislature.
Marsh involved a former managing director of Marsh USA Inc., a risk management and insurance business. According to the company, the director was a “valuable employee who had successfully performed at his position,” and had both attracted and retained business for the company. During the director’s employment, and to encourage further good performance, Marsh offered him options to purchase 500 shares of stock in Marsh’s parent company. The options vested in increments and fully vested after four years. Upon exercise of the options, the director was required to sign a non-solicitation agreement in which he promised that if he left the company within three years after exercising the options, he would not solicit certain company clients or certain employees for a period of two years.
In attempting to enforce these promises after the director left the company, the company argued that the stock options were sufficient consideration because they furthered the company’s “goodwill,” which is specifically listed as protectable interest under the Texas Covenants Not to Compete Act, TEX. BUS. & COMM. CODE § 15.50, but which had received very little attention from the courts until this case.
The appellate court in Marsh had held that stock options and similar financial incentives were not sufficient consideration because, unlike confidential information or specialized training, mere financial consideration does not “give rise to the employer’s interest in restraining the employee from competing.” The Supreme Court held that this was the wrong test to apply, and thus overruled a portion of its prior decision in Light v. Centel Cellular Co. of Texas setting out this test. Instead, the Marsh Court held, the proper test is whether the consideration merely gives rise to, or is “reasonably related to,” an “interest worthy of protection.” Marsh USA Inc., 354 S.W.3d at 774-76. Under this test, the Court found, stock options were sufficient consideration because they made the employee an “owner” of the company and linked his interests with the company’s long-term business interests, including the development of solid, long-term customer and employee relationships. Thus, the stock options furthered the company’s goodwill, which is expressly an “interest worthy of protection.” The Court stressed, however, that the “hallmark” of enforcement was whether the particular restrictions at issue are reasonable and do not impose greater restraints than necessary to protect the employer’s interests. Id. at 777. The Court did not attempt to determine whether the particular restrictions at issue in this case were reasonable, but sent the case back to the trial court to make this determination.
As the three dissenting Justices pointed out, the Court’s opinion in Marsh leaves unclear what other forms of financial benefit create sufficient business goodwill. The majority opinion could conceivably be read to suggest that any form of financial consideration to any employee – such as a bonus, promotion, or even payment of a salary – could further business goodwill, and thus satisfy the majority’s test. The majority does not directly address this point, except perhaps to explain that stock options generally further goodwill because they are designed to give the employee a greater stake in the company’s performance and in its long-term relationships with customers and employees, and to note that the employee at issue was a valued high-level employee who had already been successful in developing customer relationships. It is thus possible that other fact patterns involving stock options may not necessarily be sufficient to support a noncompetition agreement. It will take further court decisions to sort out these and other open questions after Marsh.