A Question of Goodwill: Texas Covenants Not to Compete
The Texas Supreme Court has upheld a non-compete agreement based on an employer's goodwill. Learn more about non-compete agreements from Schachter Harris, LLP.

November 05, 2011 /24-7PressRelease/ -- In the recently decided Marsh USA v. Cook, The Texas Supreme Court appears to have upheld a covenant not to compete based on protecting the employer's goodwill.

The problem with the decision, made by a sharply divided court, is it appears to allow an employer to buy a not to compete clause from an employee with the promise of stock options. Cook, an employee of Marsh, was offered stock options in exchange for signing a non-compete clause.

According to Dallas non compete agreement attorneys, restraints in trade are generally illegal under Texas Law. However, under Texas Business & Commerce Code ? 15.50(a), a noncompetition agreement is enforceable if it is reasonable in time, scope and geography and, as a threshold matter, "if it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made."

Light v. Centel Cellular Co. of Texas

Prior to Marsh, in Light v. Centel Cellular Co. of Texas, the Supreme Court used a two-part test for determining whether a non-compete provision is ancillary to or part of an otherwise enforceable agreement. To pass the test:

1. The consideration given by the employer in the otherwise enforceable agreement must give rise to the employer's interest in restraining the employee from competing; and 2. The covenant given by the employee must be designed to enforce the employee's consideration or return promise in the otherwise enforceable agreement.

The Texas Supreme Court concluded in Marsh USA v. Cook, "the covenant not to compete is 'ancillary to or part of' an otherwise enforceable agreement because the business interest being protected (goodwill) is reasonably related to the consideration given (stock options)."

What is not answered is the question of how issuing stock options to an employee affects the goodwill of a business after the employee has left the business.

Goodwill and Consideration

The long (2,600 words) concurring opinion by Justice Willett spent much time discussing the concept of goodwill. He states, "it is not enough merely to mutter the word. You cannot simply buy a covenant not to compete."

And, "The evidentiary record must demonstrate special circumstances beyond the bruises of ordinary competition such that, absent the covenant, [the employee] would possess a grossly unfair competitive advantage."

But because the record from the lower courts was inadequate, Justice Willett was willing to allow the case to go back to the trial court on remand to fill in the details of how Marsh's goodwill was protected by the noncompete.

Consideration

The dissent was even more critical of the majority's opinion in this business litigation case. Justice Green notes the real question is consideration, "The dispute is whether the consideration given to allegedly protect the employer's goodwill gives rise to an interest in restraining competition."

The problem, as the dissent sees it, is that the majority equates goodwill with consideration. The dissent notes that he, "fails to see the difference between 'an interest worthy of protection' (in this case, Marsh's goodwill), and 'the employer's interest in restraining the employee from competing' (in this case, Marsh's protection of goodwill)."

A case from federal court interpreting Texas noncompete law, Olander v. Compass Bank, seems to isolate the question: there, the employer failed to "articulate any coherent theory explaining how [a] promise ... to grant the right to buy stock at a set price ... gives rise to an interest in restraining [the employee] from competing after he has left [the employer]".

The Marsh decision would appear to be exactly the situation that Justice Green complained of, and which previously had been prohibited by Texas courts: that of an employer buying a noncompete. As the dissent puts it, "If any financial incentive that can encourage an employee to create more goodwill can satisfy the consideration prong of the Act, then we might as well ignore the consideration requirement all together. Under the Court's reasoning, a raise, a bonus, or even a salary could support an enforceable covenant."

Aftermath

For the lower courts in Texas, Marsh appears to provide limited guidance to determine what constitutes adequate consideration to satisfy the Act.

Justice Willett lays out the issue future court decisions will wrestle, including how to know the difference between an agreement that merely protects good will and one that attempts to buy noncompetition.

"Marsh does not argue that the noncompete was needed here to protect costly investments in specialized training or to ensure its trade secrets or other confidential information do not wind up on WikiLeaks. Marsh speaks of safeguarding its goodwill, and that is a protectable interest. But uttering the word goodwill is not enough; magic words do not boast auto-enforceability. Marsh must demonstrate that it is not invoking goodwill to camouflage a less noble interest: escaping future competition from Cook."

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