In a Groundbreaking Decision, the Texas Supreme Court Substantially Broadens the Universe of Enforceable Noncompetes

For many years, Texas appellate courts have held that stock, stock options, and other similar forms of remuneration cannot be sufficient consideration for a covenant not to compete.  Instead, as the courts have generally held, only confidential information or specialized training may be sufficient consideration.  In one fell swoop, the Texas Supreme Court has now overruled this substantial body of law.  In Marsh USA Inc. et al. v. Cook, Case No. 09-0558 (Tex. June 24, 2011), http://www.supreme.courts.state.tx.us/historical/2011/jun/090558.pdf, the Texas Supreme Court ruled by a 6-3 majority that stock options are sufficient consideration for a noncompete because they give rise to the employer’s interest in protecting its business “goodwill.”  The Court cautioned, however, that the “hallmark” of enforcement remains whether the particular restrictions at issue are reasonable and do not impose a greater restraint than necessary to protect the employer’s interests. 

This case gives employers more ways to contractually restrain employees from competing.  No longer is providing confidential information or specialized training the only safe option.  That said, the case raises important new questions about (1) what forms of financial benefit other than stock options may be sufficient consideration for a noncompete, and (2) how the courts will determine the reasonableness of the restrictions in agreements involving financial benefits.  The case and these issues are discussed in greater detail below.     

The FactsMarsh involves 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.  (The agreement also required the director to maintain the confidentiality of Marsh’s trade secrets, but the Court did not examine whether the provision of confidential information was a basis for enforcing the noncompete.)

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 an expressly protectable interest under the Texas Covenants Not to Compete Act, Tex. Bus. & Comm. Code § 15.50.

The Holding:   Previous appellate court precedent 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.”  In Marsh, 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.”  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.  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. 

Significant Open Questions —    

What other forms of benefits will suffice and in what fact patterns?  As the three dissenting Justices forcefully pointed out, the Court’s opinion 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.   

What is reasonable?   How will the courts measure the reasonableness of temporal, scope of activity, and geographical restrictions when the only valid consideration is stock options or similar financial benefits?  To date the case law that has developed on the issue of reasonableness has focused on whether confidential information and/or specialized training that the employee has received is substantial enough to justify the particular restrictions in the agreement.  But what facts become relevant when examining financial benefits and their impact on business goodwill?  For example, does the amount or form of the financial benefit matter, including any vesting or similar restrictions?  How is the employee’s “value” to the company to be determined?   

The Bottom Line for Employers:

Employers who want to restrain employee competition now have more options at their disposal.  We know that at a bare minimum, providing stock or stock options to a higher-level, valued employee will satisfy the Marsh test.  It is an open question as to whether other forms of remuneration – such as a bonus, promotion to a higher position, or salary increase – will suffice, and in what fact patterns. 

Employers must also remember that just because a noncompete agreement is based on sufficient consideration does not mean that courts will enforce all of its restrictions as to time, scope of activity, and geography.  Whether particular restrictions will be enforced depends on whether those restrictions are reasonable given the facts and circumstances of the case.   When drafting noncompetes based on stock options or similar financial benefits, employers will need to give careful consideration to the restrictions and whether they are justified by factors such as the employee’s position within the company, the employee’s access to confidential information and trade secrets, his or her performance, the amount of financial benefit being provided, and similar considerations.  Employers also need to keep up with the precedent that develops in this area.