Texas Non-compete Agreements That Do Not Bar Competition, But Rather Impose Monetary Penalties For Competing

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.

The rules regarding the enforceability of noncompetition agreements also apply to agreements that do not expressly prohibit a former employee from competing, but instead impose a severe economic penalty on the departing employee if he engages in competition. See Peat Marwick, 818 S.W.2d at 388 (“We hold that provisions clearly intended to restrict the right to render personal services are in restraint of trade and must be analyzed for the same standards of reasonableness as covenants not to compete to be enforceable.”). See also Frankiewicz v. Nat’l Comp Assocs., 633 S.W.2d 505, 507 (Tex. 1982) (holding that an agreement forfeiting renewal commissions in the event of competition is a restraint on trade and is unenforceable unless the restrictions are reasonable). The reason is as follows:

If the damages provided are sufficiently severe, then the economic penalty’s deterrent effect functions as a covenant not to compete as surely as if the agreement expressly stated that the departing member will not compete. The practical and economic reality of such a provision is that it inhibits competition virtually the same as a covenant not to compete.

Haass, 818 S.W.2d at 385–86.

For example, in Drennen v. Exxon Mobil Corp., 367 S.W.3d 288 (Tex. App. – Houston [14th Dist.] 2012, pet. granted), the plaintiff worked for Exxon for 31 years. In August 2007, he tendered his retirement papers. During his employment, Drennen participated in Exxon’s Incentive Program that awarded restricted stock awards and bonuses to reward high-performing employees and to dissuade high-achieving executive-level employees from leaving Exxon to work for competitors. At his retirement, Drennen had 73,900 shares (approximately $6.2 million) of Exxon stock through the Incentive Program.
The Incentive Program allowed Exxon to cancel the employee’s awards if he engaged in “detrimental activity.” Detrimental activity was defined, in relevant part, as the employee’s acceptance of duties to a third party that creates or appears to create a material conflict of interest and includes becoming “employed or otherwise engaged by an entity that regulates, deals with, or competes with” Exxon. The Incentive Program provided that New York law would be used to govern the agreement. The program also lacked any restrictions as to time, geographic area or scope of activity that might constitute detrimental activity.

After Drennen retired, he interviewed for a position with the Hess Corporation, a global, integrated energy company. Drennen informed Exxon that he was considering taking a position with Hess and Exxon warned Drennen that he would likely forfeit his incentive awards if he accepted the position. Nonetheless, Drennen accepted the job with Hess and Exxon notified Drennen that his incentive awards were canceled.

Drennen sued Exxon on a variety of theories. Exxon won following a jury trial. Drennen appealed arguing that the “detrimental activity” clause of the Incentive Program was tantamount to a noncompete that was unenforceable under Texas law. The Court of Appeals reasoned that under Texas law, “covenants that place limits on former employees’ professional mobility are restraints of trade and are governed by the Covenants Not to Compete Act.” Id. at 295. According to the Court of Appeals, the Act applies regardless of whether the agreement at issue expressly prohibits an employee from competing or subjects the employee to severe economic penalty if he engages in competition. Id. Because the “detrimental-activity” provision subjected Drennen to a severe economic penalty if he competed (i.e., a forfeiture of over six million dollars), the Act applied. It was undisputed that the Incentive Program lacked limitations as to time, geographical area and scope of activity to be restrained, and therefore was not enforceable under Texas law. Id. The Texas Supreme Court, however, granted review of this case earlier this year.

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