Forfeiture Provision in Executive Bonus Compensation Incentive Program is Not a Covenant Not to Compete Under Texas Law

The Supreme Court of Texas issued its opinion in Exxon Mobil Corporation v. Drennen this past week considering whether New York choice-of-law provisions in a Texas based corporation’s executive bonus-compensation incentive programs are enforceable.  The Court’s decision ultimately turned on whether or not a forfeiture provision in those programs constituted a covenant not to compete under Texas law.

The programs provided that an employee would forfeit his outstanding awards if he engaged in “detrimental activity” or resigned.  “Detrimental activity” was defined by the programs to include becoming employed by an entity that regularly competed with the company.  After being informed that he would be replaced, the executive in this case resigned and later accepted employment with a competitor of the company.  Exxon then terminated his outstanding incentive awards under the detrimental activity provisions.  Drennen filed suit seeking a declaratory judgment that the detrimental activity provisions were being utilized as covenants not to compete, were unenforceable, and were an impermissible attempt to recover monetary damages for an alleged breach of such covenant.  The jury found in favor of Exxon, the court of appeals reversed and ordered the trial court to render judgment in favor of Drennen.

The Court’s Analysis

The Supreme Court’s analysis started with a consideration of whether the programs’ choice of law provisions selecting New York law were enforceable.  The court noted that Texas recognizes the party autonomy rule under which parties may agree to be governed by the law of another state.  The Court previously set forth the  framework for determining whether such a provision is enforceable in DeSantis v. Wachenhut Corp. which adopted Section 187 the Restatement (Second) of Conflict of Laws.

The Court found that under Section 187, the parties had a reasonable basis for choosing New York law, Texas had a more significant relationship to the transaction and the parties than New York, and Texas had a materially greater interest then New York in whether the agreement was enforced.  The Court’s analysis of whether the choice of law provision was enforceable then turned to whether or not the application of New York law would be contrary to a fundamental policy of Texas.

The Court noted that while it had not previously defined “fundamental policy,” it had determined that the law governing enforcement of non-competes was a fundamental policy of Texas in its DeSantis opinion.  The question in this case was whether or not Exxon’s incentive programs, and the forfeiture provisions specifically, constituted a covenant not to compete.  If the forfeiture provision was in fact a covenant not to compete, then enforcing the choice of law provision would implicate a fundamental policy of Texas and its law governing the enforcement of non-compete agreements.

In Marsh USA  Inc. v. Cook, the Court provided a general definition of a covenant not to compete as a covenant “that places limits on former employees’ professional mobility or restrict[s] their solicitation of the former employers’ customers and employees.”  The Court found that the restrictions in Exxon’s incentive plans did not fit this general definition because Drennen did not make a promise not to compete or to solicit customers or employees under the forfeiture provision.

The Court also identified a key difference between non-compete provisions and forfeiture provisions in that the former are designed to protect a company’s investment in its employee by restricting that employee’s post-employment activities while the latter are designed to promote loyalty through rewards without restricting an employee’s post-employment activities.  In this case Drennen did not promise to refrain from competing with Exxon, rather, he agreed to continued loyalty as a condition to the receipt of his outstanding bonus compensation.  Drennen was not prohibited by the agreement from any post-employment activities meaning that Exxon had no legal right to prohibit his employment with its competitor (at least not one that it tried to enforce).

Since the forfeiture provision was not a non-compete, and there was no other fundamental policy implicated by the provision, the Court found that enforcement of the New York choice of law provision would not contravene a fundamental policy of Texas.  The Court then applied New York law to the facts to determine that the New York’s “employee choice” doctrine applied and that the forfeiture clause should be enforced.

A Change In Texas Policy?

In its analysis of Texas’s public policy the Court noted a potential shift in Texas policy regarding the enforcement of Texas laws on companies operating in Texas and also the application of out of state laws under choice of law provisions in Texas.  I’ve excerpted the language below:

With Texas now hosting many of the world’s largest corporations, 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.

This appears to be a signal from the judiciary that as Texas continues to grow as a business friendly state and as businesses continue to move to the state, the state’s courts will be increasingly willing to forgo a strict application of Texas laws to those companies.  The courts will allow companies based in Texas to elect to have their employment agreements governed by laws from other states even when those agreements are with Texas based employees.

5 Things Your Company Should Consider When Deciding Whether to Enforce a Covenant Not To Compete

Should your company enforce a non-compete provision when an employee leaves to work for a competitor?  I can’t really answer that question beyond saying in typical attorney fashion that, “It depends.”  What I can do is discuss some of the factors your company should consider when making that decision and some of the questions it should answer.

Importance of the Interest Your Company Seeks to Protect

This is the single most important factor.  The purpose of a covenant not to compete or any other restrictive covenant is to protect a legitimate business interest. The most common scenario involves preventing the disclosure of confidential or proprietary information.

So how important is the information your company is concerned about?  Is there a significant risk of exposure?  Did the former employee actually have access to the types of information your company seeks to protect?  Is that information included within the scope of the non-compete provision?

The Employee’s Position With and Value To His New Employer.

What is the former employee’s position at his new employer?  What are his duties in that position? Is there any connection between the types of information the employee had access to at your company and the duties or responsibilities of his new position?  Is there a likelihood that the former employee will use your company’s confidential information in performing his duties for his new employer?

And how valuable is the employee (and the position) to his new employer?  The answer to this question is important because it will provide some insight into how the new employer may respond to an attempt to enforce a non-compete agreement.  If the employee is critical to the company’s business then his new employer is more likely to defend his position.  On the other hand, some lower level positions may not be worth the effort and expense of litigation.

Effects of Not Enforcing the Non-Compete Agreement.

This is another important factor.  What happens if you do not enforce the non-compete agreement?  Employees gossip.  No doubt they will notice if an employee leaves to work for a competitor and your company does not enforce the non-compete agreement.  Not enforcing the non-compete provision may cause other employees to ignore it under the assumption that your company will not enforce it.

The decision to not enforce a non-compete may also come up in subsequent litigation.  If another employee with access to similar information leaves for a similar position with a new company, then your company may have difficulty enforcing the non-compete agreement if you did not try to enforce it the first time.  At the very least you will likely have to answer the question of why you chose not to enforce the non-compete in the first instance.

Impact of Litigation On Business Operations.

You should always consider the impact of potential litigation on your company.  Understand that the former employee’s managers and other high-level employees could become witnesses during the litigation.  Have you given thought about the disruption to your company’s business that would be caused by them having to take the time to prepare for and sit through depositions?  What about testifying at trial?  Have you considered the type of questions your managers and employees may have to answer during a deposition?  Could you end up exposing more information to the other party through litigation than you risk by not enforcing the non-compete provision?

History Between Your Company and the New Employer.

What about the history between your company and the new employer?  Have you hired any employees from the new employer recently?  Were they subject to a non-compete agreement at the time?  Are there any other pending disputes between the companies?

It is certainly worth considering whether an attempt to enforce this non-compete provision could lead to more complicated litigation.

This list is by no means exhaustive and every circumstance will require its own evaluation, but hopefully this provides you with some guidance on the factors your company should consider when deciding whether or not to enforce a non-compete agreement.

Notices of Forfeiture of Right to Transact Business Mailing this Week

From the Comptroller’s Office:

On Aug. 8, the Comptroller will mail the “Texas Notice of Intent to Forfeit Right to Transact Business” form to taxable entities that failed to file the 2014 Franchise Tax report that was due May 15, 2014, if an extension of time to file was not requested and granted. The Comptroller will also send this notice to companies that failed to file a complete report or to pay the full amount due.

By law, the right to transact business cannot be forfeited before 45 days from the date the Comptroller mails the notice. During this period, when the company has received the notice of intent to forfeit, but the forfeiture has not yet occurred, the company’s status on the Comptroller’s Taxable Entity Search will remain as “active.”

http://www.window.state.tx.us/taxinfo/taxpnw/tpn2014/tpn1408.html

 

It’s time to confirm your company filed its annual franchise tax reports and keep an eye on your mailbox.  The excerpt above is from the Comptroller’s office which is mailing these notices this week.   If you receive a notice of intent to forfeit your company’s right to transact business you should take action immediately.

After the 45 day period the Comptroller’s may forfeit a taxable entity’s right to transact business.  This creates personal liability for each director, officer, or manager of the taxable entity for any debts incurred by the taxable entity after the date of forfeiture.  Obviously this is a scenario your company will want to avoid.

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