Rodgers and Hammerstein said that the farmer and the cowman should be friends.1 Well, an August 2014 Texas Supreme Court non-compete case, upholding a New York choice-of-law provision, suggests that Texas and New York are already legal "podners" in the quest to enforce these agreements.
First, as always, a little bit of background: Practitioners in this area are aware that most courts disfavor enforcement of non-competes; they are viewed as restraints of trade and read narrowly.
In New York, courts require employers to identify a legitimate business interest, such as protection of trade secret information, to enforce these—and beyond, the agreements should be narrowly tailored in terms of restricted geography and time limits.
In recent years, though, New York courts have provided alternative avenues for enforcing non-competes—through application of the "employee choice" doctrine, where an employee can choose either to accept limitations in a non-compete or forfeit unvested employee benefits.
Some states, of course, are far more hostile to non-compete agreements. California, for one, banishes them, viewing them as a violation of public policy.
Texas, too, has been a far tougher state in which to enforce non-competes, although (as discussed further below) the courts have in recent years loosened some serious statutory restrictions.
In response to economic studies suggesting that non-competes inhibit free enterprise and the entrepreneurial spirit, this summer Massachusetts Governor Deval Patrick sought to mimic California's prohibition on the theory that Massachusetts is losing out to California when it comes to nurturing start-ups. While the proposal went nowhere, the governor hopes that the Legislature will pass a compromise law in its next session.
And in New Hampshire, also this summer, the Legislature imposed new restrictions on non-competes, requiring that, to be enforceable against a newly hired employee, the employer must "provide a copy of such agreement to the potential employee prior to the employee's acceptance of an offer of employment."
New York's New Partner: Texas
Exxon Mobil Corp. v. Drennen,2 a decision of the Texas Supreme Court decided on Aug. 29, 2014, makes New York and Texas unlikely partners in the enforceability of non-compete agreements.
In Texas, a covenant not to compete is enforceable only if, among other things, "it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made…"3
In the past, the requirement that the covenant be "ancillary" or "part of an otherwise enforceable agreement" rendered these agreements quite difficult to enforce. In recent years, though, the courts loosened these restrictions, holding that the agreement may be for an at-will employment relationship,4 that a non-compete may be supported by implied promises from the employer to provide confidential information,5 and that a stock options award can have a sufficient nexus to the company's goodwill to warrant a non-compete.
In Drennen, though, the Texas Supreme Court looked to New York law to uphold enforceability of a non-compete agreement, where the agreement provided for New York choice of law, and where the agreement passed muster under New York's "employee choice" doctrine. The court held:
While Texas law may or may not permit the enforcement of these detrimental-activity provisions, New York law does. Application of New York law, resulting in the enforcement of these provisions, does not contravene any fundamental policy in Texas.
The plaintiff in Drennen worked for the company for over 30 years and received deferred incentive compensation under a variety of programs. The programs contained termination provisions that allowed the company to terminate outstanding awards if he engaged in "detrimental activity," which was defined as, among other things, becoming employed by a competitor.
The plaintiff was told his job was likely to change and in response, he chose to resign and go to work for a competitor. The plaintiff had 57,200 shares in the restricted period when he resigned, and so the company cancelled the outstanding shares due to his undertaking a "detrimental activity."
The trial court and intermediate appellate court agreed with the employee that the "detrimental activity" provisions were a form of unenforceable non-compete agreement under Texas law. But the Texas Supreme Court reversed, concluding, first, that New York law applied, and second that, in any event, the "employee choice" agreement was not a non-compete, but was a forfeiture agreement.
The court applied the Restatement (Second) of Conflict of Laws §187 test, which considers (a) whether there is no substantial relationship between the transaction and the state chosen, and (b) if application of the law chosen would violate a fundamental public policy of a state with a materially greater interest than the one chosen.
Here, the company's incentive programs provided for application of New York law, but the company is headquartered in Texas and incorporated in New Jersey, and the plaintiff lived in Texas (although he had lived in New York and worked for the company in the 1980s).
To find a relationship to New York, the court focused on several seemingly attenuated considerations. It pointed out that the company's outside counsel was a New York law firm. It noted that the company's shares were traded on the New York stock exchange and valued on that exchange. The court concluded these connections to New York were sufficient.
The court then addressed the second part of the test and concluded that the state with the most significant relationship to the transaction is Texas, and that Texas has a materially greater interest in the transaction than New York.
Nevertheless, in applying the "fundamental public policy" part of the analysis, the court concluded that the contract at issue was not a covenant not to compete, but instead was a forfeiture agreement under the New York employee choice theory.
The court emphasized that forfeiture agreements reward loyalty rather than prohibit future employment opportunities, making them different from covenants not to compete. And even if such a provision might be unenforceable as an unreasonable restraint of trade under Texas law, the court held that the New York choice-of-law provision rendered the issue moot.
The court noted that Texas now hosts many of the world's largest corporations, and "our public policy has shifted from a patriarchal one in which we valued uniform treatment of Texas employees from one employer to the next above all else, to one in which we also value the ability of a company to maintain uniformity in its employment contracts across all employees, whether the individual employees reside in Texas or New York."
The court ultimately concluded that when the importance of allowing parties to use contracts to gain uniformity is factored in "we cannot conclude that applying New York law [to a forfeiture provision] is 'contrary to a fundamental policy' of Texas."
Once the court had decided that the forfeiture clause would be governed by New York law, it made short work of the enforceability issue. The "employee choice" doctrine of New York provides that "a restrictive covenant will be enforceable without regard to reasonableness" so long as the employee voluntarily left his or her employment or was terminated for cause.
Consequently, the plaintiff's reasonableness challenges to factors such as lack of geography in the "detrimental activity" restriction were irrelevant.6
Interestingly, the court's decision is also consistent with a recent decision of the U.S. Court of Appeals for the Second Circuit, Martinez v. Bloomberg,7 which enforced an English choice-of- law provision in an employment agreement.
The U.S. Supreme Court recently also came down strongly in favor of acceptance of choice-of- forum and choice-of-law agreements. In Atlantic Marine Construction Co. v. The United States District Court for the Western District of Texas,8 the court held:
When parties agree to a forum-selection clause, they waive the right to challenge the preselected forum as inconvenient or less convenient for themselves or their witnesses, or for their pursuit of the litigation. A court accordingly must deem the private-interest factors to weigh entirely in favor of the preselected forum.
Interestingly, on an international basis, the challenge to enforce non-competes across borders remains significant. In Europe, the issue of forum selection is a matter of statute, and employers may only sue the employees where they are domiciled. Clearly, U.S. employers have more flexibility.
For example, in Samengo-Turner v. J & H Marsh & McLennan (Services),9 an English Court of Appeal refused to give effect to a restrictive covenant's New York jurisdiction clause, where the London-based employees were employed by an English company that belonged to a group of companies headquartered in New York. The brokers had applied to the English court for an anti-suit injunction to stop New York proceedings that had been initiated in the Southern District.
New York's employee choice doctrine, coupled with a renewed acceptance of choice-of-law provisions, may provide a solution for employers who seek to enforce non-compete agreements across state borders.
Of course, these provisions do not prevent the employee from going to a competitor, but only create a financial price for doing so, and the competitor may cover the employee's loss, which would negate the disincentive.
But companies looking for enforceable ways to restrict employees' ability to work for a competitor in the face of increasing hostility to non-competes may find application of New York law and enactment of a forfeitable deferred compensation incentive plan an acceptable approach to the problem.
1. Rodgers and Hammerstein, "The Farmer and the Cowman," from the musical Oklahoma
(opened on Broadway in 1943).
2. 2014 Tex. LEXIS 760, 57 Tex. Sup. J. 1346 (Aug. 29, 2014).
3. TEX. BUS.??& COM. CODE §§15.50, 15.51.
4. Alex Sheshunoff Management Services v. Johnson, 209 S.W.3d 644 (Tex. 2006).
5. Mann Frankfort Stein & Lipp Advisors v. Fielding, 289 S.W.3d 844 (Tex. 2009).
6. For a fuller discussion of Drennen, see S. McDonald, "Texas Supreme Court Rules for
Exxon: A New Day for Noncompete-Triggered Forfeitures in Texas?" (Sept. 8, 2014), http://www.littler.com/publication-press/publication/texas-supreme-court-rules-exxon-new-day-noncompete-triggered-forfeitur.
7. 740 F.3d 211 (2d Cir. Jan. 14, 2014).
8. 134 S. Ct. 568, 2013 U.S. LEXIS 8775 (U.S. Dec. 3, 2013).
9. (2007) EWCA Civ 723; [2007 I. Pr. 52].
Philip M. Berkowitz is a shareholder and U.S. co-chair of Littler’s International Law Practice Group. He is based in the firm’s New York City office. This article is reprinted with permission from the September 11, 2014 issue of the New York Law Journal. © ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.