United States: Can Former Employees Be Barred From Competition Without An Enforceable Non-Compete Agreement?

Last Updated: October 3 2014
Article by Gary Lawson and Robert M. O'Boyle

The Supreme Court of Texas, in Exxon Mobil Corp. v. Drennen (No. 12-0621), on August 29 of this year may have provided a blueprint to Texas employers to preclude competition from some select former employees without having to meet the requirements of an enforceable covenant not to compete. The Supreme Court allowed ExxonMobil to enforce a "detrimental activity" (competing employment) clause in a restricted stock agreement that provided that Drennen forfeited his right to the stock when he went to work for a competing employer, finding that the provision in question is not a covenant not to compete under Texas law.

Drennen was a geologist who worked for ExxonMobil for thirty-one years and had been awarded restricted stock under ExxonMobil's Incentive Program. The ExxonMobil Incentive Program provided that stock would be forfeited if the former employee went to work for a competing enterprise. After retiring from ExxonMobil, Drennen accepted a position with Hess Corp. and ExxonMobil cancelled the remainder of Drennen's incentive awards.

The Court differentiated between the Incentive Program and a covenant not to compete. "[T]here is a distinction between a covenant not to compete and a forfeiture provision in a noncontributory profit-sharing plan because such plans do not restrict the employee's right to future employment; rather, these plans force the employee to choose between competing with the former employer without restraint from the former employer or accepting benefits of the retirement plan to which the employee contributed nothing."

The Supreme Court went to some length to distinguish the restricted stock grant in Drennen from the stock option agreement that was analyzed as a covenant not to compete in Marsh USA v. Cook, 354 S.W.3d 764, 769 (Tex. 2011). The Court observed that in Marsh the employee had to do three things to get exercise his stock option: (i) notify the employer he was exercising his option, (ii) pay for the stock at the discounted price, and (iii) sign a non-solicitation agreement.

Tex. Bus. Commerce Code § 1.301(a) provides that "[W]hen a transaction bears a reasonable relation to this state and also to another state or nation the parties may agree that the law either of this state or of such other state or nation shall govern their rights and duties." Despite the facts that Drennen was employed by ExxonMobil for twenty-eight out of thirty-one years in Texas, and ExxonMobil is headquartered in Texas, ExxonMobil was able to establish a reasonable relation between the Incentive Program and the State of New York. The Court found a "reasonable relation" because Drennen had worked for ExxonMobil in New York for three years, ExxonMobil's stock is traded in New York, and ExxonMobil, which employs individuals in numerous states and countries, needs consistency in its Incentive Program awards.

Having found that New York law applies, the Court also determined that the "detrimental activity" clauses in the Incentive Program are enforceable under New York's "employee choice" doctrine.

One might wonder if the Supreme Court's decision was in part driven by the simple notion that parties should be bound by the terms they contractually agree to, especially if they are highly compensated, perhaps wealthy and smart executives. Such was not the stated reason for the decision, however.

If the goal is to have an effective New York choice-of-law forfeiture of stock option rights outcome, since some employers might also wish to be able to actually restrain a former employee from going to work for a competitor, attempting to do both and thus adding a signed Marsh non-solicitation agreement, could well be a smart lawyer's or clients undoing. Ask for too much from the employee, seek to limit her/his professional mobility, and you may have a Marsh, not a Drennen, outcome.

So, what should clients do who want the result Exxon obtained?

Check the law, make sure Drennen has not been overturned, either by a later court decision or an act of the Texas legislature, and then, ever so carefully, draft the right agreement terms and choice of law provision.

Perhaps lawyers should consider bolstering their choice of law provision by adding contractual language stating that the parties intend the agreement's forfeiture and choice of law provisions to be afforded full meaning and application, stating further that the employee has had an opportunity to be, and has in fact been represented by counsel of his/her own choosing, who could have and is deemed to have explained the consequences of his client's contractual agreement, that he/she "intended to say what he meant and means what he said", and that in interpreting this agreement, a court should enforce the agreement of the parties as written?

If the parties don't have nearly equal bargaining wisdom if not also clout, then perhaps another legal theory would be argued, that any such terms written for the benefit of the employer constituted a contract of adhesion and should not be enforced as written?

A near final word of warning; one of the final statements by the Supreme Court was–

"Whether such provisions in non-contributory employee incentive programs are unreasonable restraints of trade under Texas law, such that they are unenforceable, is a separate question and one which we reserve for another day. See Haass, 818 S.W.2d at 385–86"

The "final" final word is about ERISA. If the promised benefits are deferred until termination of employment, they may be "pension benefits" under ERISA, even if not offered under a tax qualified retirement plan. See Tolbert v. RBC Capital Markets Corporation (5th Cir., 2014). State law could arguably be preempted in determining the permissibility of a forfeiture provision if included in an ERISA-covered plan. See ERISA sec. 514.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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