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Texas Supreme Court Expands Scope of Enforceable Non-Competes

June 30, 2011

The Supreme Court of Texas, in a closely divided opinion, has just made it easier for employers to enter into and enforce covenants not to compete in Texas.   In Marsh USA Inc. and McLennan Companies, Inc. v. Cook, No. 09-0558, 2011 Tex. LEXIS 465 (Tex. June 24, 2011),  the Court broke new ground in ruling that stock options constitute sufficient consideration to support a non-compete agreement. And going further still, the Court made clear that the stock options, when issued during an employee's employment, would support the enforcement of a non-compete to protect confidential information that the employee had access to prior to execution of the non-compete.  There is every indication that the ruling will apply more broadly than stock options to include other kinds of consideration.   

The underlying facts in Marsh were straightforward.  Defendant Rex Cook had been an employee of Marsh, an insurance broker and risk adviser, since 1983.  In 2005, Cook signed an agreement allowing him to exercise Marsh stock options at a discounted price.  That agreement also provided that if Cook left the company within three years of exercising the stock options, he agreed not to compete with Marsh.  Specifically, he agreed that he would not solicit or accept business of the type offered by Marsh for a period of two years after his termination.  Cook also agreed that he would not solicit any Marsh employees who reported to him. Upon Cook's departure, Marsh moved to enforce the noncompete. 

Texas has historically been hostile to non-competes.  Indeed, under Texas law, a noncompete is enforceable when: (1) there is an otherwise enforceable agreement and (2) the covenant not to compete is "ancillary to or part of" the agreement.  At issue in Marsh was whether the noncompete covenant was ancillary to or part of the otherwise enforceable stock option agreement.  The Supreme Court of Texas had previously held that to be ancillary to or part of an enforceable agreement, the consideration for the agreement must "give rise to the employer's interest in restraining the employee from competing" and that the covenant "must be designed to enforce the employee's consideration or return promise" in the agreement.  Under that articulation of the standard, new employment contracts were sufficient consideration for a non-compete, but other inducements could be suspect.  Following that rationale, the trial and intermediate appellate courts found Cook's covenant was invalid because the consideration, favorable stock options, did not "give rise" to the protectable interests in goodwill.

The Supreme Court of Texas reversed and remanded finding that this formulation of the "giving rise" standard was overly restrictive.  Instead, the court held that consideration is sufficient when it is "reasonably related to an interest worthy of protection, such as trade secrets, confidential information or goodwill."  Applying that standard to the case at bar, the court found that the stock options were reasonably related to the protection of business goodwill and that Cook's noncompete was therefore ancillary to an otherwise enforceable agreement.

The Court remanded to the lower court the question of whether the noncompete was reasonable as to time, scope of activity, and geographical area.  Three justices dissented, arguing that the decision is antithetical to the Court's prior holdings that consideration for a covenant not to compete must give rise to an interest in restraining trade.

Marsh is welcome news to employers seeking to enforce non-competes in Texas.  Its expansion of the range of consideration that will support a non-compete, and clarification that post-hire non-competes will serve to protect information previously disclosed to an employee, affords robust protection to employers seeking to safeguard their confidential information in Texas.

For more information, please contact the professional(s) listed below, or your regular Crowell & Moring contact.

Ellen Moran Dwyer
Partner – Washington, D.C.
Phone: +1.202.624.2574
Mark A. Klapow
Partner – Washington, D.C.
Phone: +1.202.624.2975