Abstract
Most states allow employers to restrict their employees from competing with them in the future. In Marsh v. Cook, Texas became the latest defector from a dwindling list of places where employees can transfer jobs without moving or changing careers, and without getting sued. Texas courts had steadfastly resisted non-compete agreements for decades, and its shift is the latest example in a national trend toward accepting more restrictions on competition. However, so long as dissenters remain, talented professionals will move to the states that do not permit broad restrictions. This policy outcome undermines why non-competes are accepted in the first place: promoting the state’s economy.
Keywords
Introduction
Non-compete agreements harm the economy, society, employees and even business. Yet we have seen the non-compete enforcement has generally increased across the United States. This expansion is owing to the growing importance of fairness in the analysis of non-compete agreements.
With Marsh v. Cook, Texas has firmly returned to the fold of jurisdictions determining non-compete enforceability based on equitable concepts. Inversely, Texas has now abandoned its place among the minority of states that remain resistant (if not downright hostile) toward non-compete agreements. In doing so, Texas will harm—rather than promote—its economy.
About Non-Competes Generally
A non-compete is an agreement for one party to refrain from conducting business that is similar to the other party’s business. The law generally disfavors non-competes because they restrain market forces that tend to benefit society.
Employers use non-compete agreements to protect business goodwill, trade secrets and other confidential or proprietary information; discourage former employees from later competing and prevent quick turnover. Litigation over non-compete agreements typically concerns the reasonableness of the duration and geographic area of the covenant, whether the consideration is adequate or whether there is a failure of consideration received by the employee in exchange for agreeing to the covenant, whether the agreement lacked reasonableness and the scope of activities that the promise cannot perform as a result of an overly broad covenant.
Non-Competes Harm a State’s Economy
Neither the concept nor the reasoning is new. Non-competes were unenforceable under English common law because the courts deemed them contrary to public policy. The reticence carried over into the newly formed United States.
However, as time dragged on, the states became less united, as more and more states showed a judicial or legislative tolerance for the agreements to varying degrees. By the 20th century, a trend was emerging.
Today, only a handful of states still cling to their skepticism toward non-competes. However, in their march toward protecting business from the apparently unfair burden of competition, courts have blindly ignored the complementary erosion of economic utility.
Indeed, non-competes generally are contrary to the interests of the public and employees as well as employers. This because states promote non-competes lose employees to states that restrict the agreements. All things being equal, employees gain nothing from non-compete agreements.
States that liberally enforce non-competes lose innovators to states that significantly restrict the agreements. Local economies—vis-à-vis firms—thrive through labor pooling. Indeed, two centers for technological innovation—California and Washington—have strengthened their technology sectors specifically by rejecting restrictions on competition, such as non-competes.
Assuming that all other terms and conditions of employment are equal (e.g., assuming the employment is not contingent on executing the non-compete), employees gain nothing from non-competes. To the contrary, many workers whose employment opportunities are restricted by a non-compete suffer significant setbacks in their chosen fields.
Furthermore, firms gain little in the long run because they are prospective employers as much as they are former employers. As a whole, firms’ access to the labor market in the field is substantially limited when non-competes are rampant.
History of Non-Competes in Texas
Originally, Texas produced several decisions that suggested that it was moving in lockstep with the national trend toward broader enforcement of non-competes. However, the Texas Supreme Court departed from the mainstream in an almost 20-year exercise in technical analysis that prized form over substance.
In 1987, the Texas Supreme Court reversed the state’s previous trend and instituted a demanding four-prong test for non-competes. The test touched on the underlying public policy favoring competition and contract principles in addition to legitimate interests and reasonableness.
Two years later, in 1989, the Texas legislature rejected the court’s resistance to broader non-compete enforcement by passing the Covenants Not to Compete Act.
Not to be outdone, the court struck down every non-compete to come before it for the next 4 years. So the legislature amended the act in 1993 to overrule the court again.
The court first construed the 1993 amendment in Light v. Centel Cellular Co. of Texas. The court recognized that the legislature intended to broaden the enforceability of non-compete agreements with the 1993 amendment. First, the court rejected the notion that continued employment, in an at-will position, is sufficient consideration to support an enforceable non-compete agreement.
The court then performed a highly technical analysis of the law’s “otherwise enforceable agreement at the time the agreement is made”—again emphasizing principles of contract formation (e.g., illusory promises, unilateral contracts and accepting an offer by performing one’s end of the bargain). Unsurprisingly, the court struck down the non-compete (legislation).
And so—seemingly victorious—Texas courts heavily focused on whether the employer gave enough to the employee in return for the agreement from a perspective of contract law for another two decades.
Texas Reverses of Course
Two decades passed, and the Texas Supreme Court had prevailed in a struggle against the state legislature to keep non-competes at bay.
Then, in just a few short years, the court signaled a sudden and dramatic reversal of course. The court gave a few relaxed analyses that looked to the non-compete’s reasonableness, not formalistic requirements.
Marsh v. Cook
The court completed its about-face in Marsh v. Cook. In that case, the employer offered the employee a stock option plan because he was a valuable employee. The employer wanted the employee to have a personal interest in seeing the company succeed.
The employee exercised the options after they vested, which required that he execute a non-compete agreement. The employee, however, left the company and violated the non-compete.
The employer sued, but the employee prevailed on summary judgment under Light. Because the stock option plan had not given rise to the legitimate interest in restricting competition, the non-compete was not ancillary to an otherwise enforceable agreement, 1 according to the trial court.
The Marsh court found no statutory support for Light’s proposition that the consideration give rise to the interest in restraining competition.
To the contrary, the court held that goodwill was an interest worth protecting and the stock options were sufficient consideration to support the non-compete. And that was that.
The court interpreted the statute’s “ancillary to an otherwise enforceable agreement” language not to require a direct link between the business’ legitimate interest and the consideration for the non-compete. In Marsh, this meant that the non-compete was still “ancillary” to the stock options agreement, even though the grant of stock options was not the reason the employer sought to restrict the employee’s competition.
The court made clear that its decision rested on the premise that non-competes promote the economy.
The court reasoned,
On the other hand, valid non-competes constitute reasonable restraints on commerce agreed to by the parties and may increase efficiency in industry by encouraging employers to entrust confidential information and important client relationships to key employees. Legitimate covenants not to compete also incentivize employers to develop goodwill by making them less reluctant to invest significant resources in developing goodwill that an employee could otherwise immediately take and use against them in business. Stated differently, valid covenants not to compete ensure that the costs incurred to develop human capital are protected against competitors who, having not made such expenditures, might appropriate the employer’s investment. (Marsh USA, Inc. v. Cook, 354 SW3d 764, Tex. Sup. Ct. 2011; internal citations omitted)
The court went on to say that the Act had essentially adopted and codified this rationale.
Marsh’s Progeny
In the 10 months since the court decided Marsh, only one case has discussed Marsh in significant detail.
In Travelhost, Inc. v. Brady, the court ruled that the right to use a business’ trademarks and logos, along with the opportunity to keep the revenues derived from selling advertising, would support a non-compete. Furthermore, the court concluded without discussion that the plaintiff had linked the defendants’ pecuniary interests with the plaintiff’s interest in protecting the company’s goodwill—namely, the relationships developed with its customers and advertisers.
The court relied on Marsh’s pronouncement that no requirement exists that “consideration for the otherwise enforceable agreement give [. . .] rise to the interest in restraining the employee from competing” and that “consideration for a non-compete that is reasonably related to an interest worthy of protection, such as trade secrets, confidential information, or goodwill, satisfies the statutory nexus.”
Without reading too much into the decision, it suffices to say that Travelhost is consistent with the notion that Texas courts have a new, more welcoming posture toward non-competes.
Analysis of Marsh
Texans may not like to admit that they have much in common with Californians, but before Marsh, the Lone Star State stood with a few—mostly Western—states that had stubbornly refused a national trend toward broad enforcement of non-compete agreements.
However, so long as they hold firm, the states resisting enforcement of non-competes will enjoy an advantage in their labor markets and economies. This advantage comes at the expense of states (now including Texas) that have embraced equitable principles while enforcing more and more non-competes.
Empirical studies show that the presence or absence of enforceable non-competes affects skilled employees’ decision about where to work. And not just for which employer but also which states. In other words, skilled employees go forum shopping to find employment conditions that favor mobility. This effect is called “brain drain.”
So rather than promoting human capital cultivation, as the Marsh court suggested, broader enforcement of non-competes—even reasonable ones—leaves a state’s businesses with a weaker labor pool. Furthermore, the state and public at large are harmed by losing productive (taxpaying) workers.
The Marsh court noted that the focus of non-compete enforcement is not on the individual employee. The court openly acknowledged that individuals may be burdened by such agreements. But the Marsh court failed to see that society’s interests align with individual employee interests when it comes to non-competes.
That is, so long as there is variation from state to state in the level of enforcement. A federal law would certainly mitigate brain drain. Yet a federal solution is not a realistic possibility, at least not any time in the near future.
Conclusion
In the meantime, Texas will have to live with its decision to allow broader restrictions on competition. Policy makers often prioritize social values over and above market efficiency. Just because Texas has chosen to join the mainstream of states in a policy that hurts the economy from just about every aspect does not make the decision a bad one.
Marsh, like most other states in the mainstream, analyzes non-competes in equity, that is, whether the agreement is fair. Cold utilitarian calculations have little place in fairness determinations.
However, Texas courts need to understand that they will likely pay for fairness with a weaker labor pool. Though from an economic standpoint, Marsh was a bad decision, recent cases show that the trend toward broader enforcement underlying Marsh will likely only expand at the trial court level in the near future.
The nationwide trend shows a growing acceptance of non-competes based on flawed policy. This means employees can expect the agreements to become even more commonplace as employees’ options dwindle for a more favorable jurisdiction. Attorneys representing employees will have to work harder to show the unfairness of a specific agreement, as opposed to relying on formalistic rules focusing on contract formation. Finally, a few states—like California—are blazing a new trail that resists non-competes in the face of the national trend. These jurisdictions will reap the rewards of this policy decision by attracting more of the nation’s talent.
Footnotes
Acknowledgements
Special thanks to Dallas Hammer for his assistance.
Declaration of Conflicting Interests
The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.
Funding
The author(s) received no financial support for the research, authorship, and/or publication of this article.