Covenants Not to Compete: Enforceability and Severability of Non-Compete Clauses Within Partnership Agreements in The U.S. (With Particular Emphasis to Texas Jurisdiction)

Historically, it has been considered an ethical violation for attorneys to enter into agreements which disable their ability to practice law upon their leave from employment. Noncompetition covenants supported by consideration and ancillary to a lawful contract is, however, enforceable if reasonable and consistent with the public interest. When the noncompetition covenant in an employment contract or partnership agreement seeks to restrict the right of an attorney to compete with a former law firm or partnership, factors such as the state rules of attorneys' professional conduct and the public policy behind these rules affect the enforceability of the noncompetition covenant. Today, forty-nine states in the US have adopted the view of the American Bar Association Committee's Model of Professional Conduct 5.6 or a similar version of it, which states

A lawyer shall not participate in offering or making:

1. A partnership, shareholders, operating, employment, or other similar type of agreement that restricts the right of a lawyer to participate after termination of the relationship, except an agreement concerning benefits upon retirement.
2. An agreement in which a restriction on the lawyer's right to practice is part of the settlement of a client controversy.

A client's right to choose an attorney of his/her choice is an important public policy consideration behind such covenants. A violation of the attorney's professional conduct would be a provision penalizing an attorney for undertaking any representation, which restricts the right of a lawyer to practice law. The public policy rationale behind holding such restrictive covenants among attorneys as undesirable is the limitation they place on the lawyers' professional autonomy and the client's freedom to choose a lawyer. Since public policy renders freedom of choice to clients in choosing their lawyers, no such direct restrictive covenant shall be held valid under either the majority or the minority rule.

When evaluating restrictive covenants in employment agreements, courts either take on the majority or the minority rule/view. The majority rule sets out the basic principle: contracts that violate the Rules of Professional Conduct (RPC) violate public policy, and courts hold them to be unenforceable. In a minority of jurisdictions, consideration is given to factors such as the financial stability of law firms when handling restrictive covenants. More so, for the purposes of thinking outside public policy considerations and more into the fact-based reasonableness analysis, the minority view reckons law firms to regular businesses. Hence, in determining the reasonableness of non-compete agreements, the minority view looks into other ethical Committee provisions such as Business & Commerce Code's along with Rules of Professional Conduct.

A typical non-compete clause contains time and geographic constraints on the departing attorney. In recent years, modified versions of non-compete provisions have taken the form of indirect disincentives for lawyers not to represent their former clientele. These disincentives are usually in the form of financial ones. More than often, these indirect non-compete clauses bring great discouragement for attorneys to represent clients who prefer them.

In recent years, a majority of the Courts have begun to frown upon such indirect non-compete agreements; where attorney's are enticed to choose financial gains over client representation. The following example of an indirect non-compete clause is taken from a partnership agreement in Texas (hereon referred to as the "Clause"):

The non-compete Clause within an employment contract will likely be deemed per se invalid. This article aims to shed some light on the scope of non-compete clauses within employment agreements. Throughout this article, the Clause (provided above) will be used as a hypothetical to determine whether a Texas Court would hold such a Clause valid, while exploring other jurisdictions as well.

A. MAJORITY RULE: The non-compete Clause is per se invalid.

Texas courts are divided on the issue of non-compete clauses in lawyer-partner agreements. Under Shook v. State, 156 Tex. Crim. 515 (Tex. Crim. App. 1951), the rulings of conflicting courts of equal jurisdiction are nonbinding; thus, relevant conflicting opinions must be evaluated to assess the enforceability of the clause. This unique posture of Texas on this subject matter, makes it a good place to write this article on non-compete clauses.

In Whiteside v. Griffis & Griffis, 902 S.W. 2d 739 (Tex. Ct. App. 1995), the court held that non-compete clauses in lawyer employment agreements are invalid per se. There, after leaving Griffis & Griffis, Whitehead sought to collect a goodwill payment pursuant to a shareholder agreement, despite having violated its terms by practicing within 300 miles of Griffis' San Antonio location. Citing DR 2-108 of the Texas Code of Professional Responsibility, the Court explained that, though the agreement at hand did not impose a direct restriction upon Whiteside's right to practice law, it provided a financial disincentive to compete by linking payment of a goodwill factor to geographic and time limitations on his practice. Id. at 743. The Court further explained, that the purpose of DR 2-108 is to protect the public's right to select an attorney of their choice. "Indirect financial disincentives may interfere with this right just as much as direct covenants not to compete. ...This violates both the language and spirit of DR 2-108 by restricting the practice of law." Id. at 744.

Other jurisdictions have also held such clauses to be per se invalid. For example, in Jacob v. McLaughlin & Marcus, 128 N.J. 10 (1992), the court held financial disincentive portions of lawyer employment agreements to be unenforceable. There, the plaintiffs signed an agreement upon departing McLaughlin & Marcus that effectively forfeited compensation if they continued to represent or solicit firm clients within a year of their departure. The Court cited the Rule of Professional Conduct 5.6, the underlying purpose of which "is to ensure the freedom of clients to select counsel of their choice... designed to serve the public interest in maximum access to lawyers and to preclude commercial arrangements that interfere with that goal." Id. at 18. Ultimately, the Jacob court held that while financial disincentive provisions differ from direct restrictive covenants, such provisions are unenforceable as matter of public policy.

Similarly, Cohen v. Lord, 75 N.Y. 2d 95 (1998) turned to the applicable code of professional conduct in evaluating the validity of a withdrawal agreement in legal practice. There, Cohen, a partner in Lord, resigned to become a partner at another firm in the same city. Pursuant to the partnership agreement, Cohen requested his departure compensation. This was refused by the firm, claiming Cohen violated the agreement by practicing law with another firm in the area. Citing the ABA Formal Opinions on Professional Ethics, No 300 (1961), the Cohen Court noted that the Ethics Committee concluded "it was unethical for an attorney to insert a restrictive covenant in a contract of employment with another attorney..." Id. at 98. The court explained that while the provision in question did not expressly prohibit a partner from practicing, "the significant monetary penalty it exacts... constitutes an impermissible restriction on the practice of law... and [would] realistically discourage and foreclose a withdrawing partner from serving clients... and would thus interfere with the client's choice of counsel." Id. On this basis, the court found the clause in Cohen's partnership agreement to be unenforceable.

Thus, on the basis of the holdings in Whiteside, Jacobs, and Cohen, as well as the substantial public interest in providing clients with access to legal representation to their choosing, Courts will most likely find the restrictive Clause per se invalid and unenforceable on the basis of ethical violation and public policy concerns.

- Evolution of the majority rule in Gray v. Noteboom

More recent Texas cases have begun to expand their analysis of lawyer partnership agreements. In Gray v. Noteboom, 159 S.W. 3d 750 (Tex. Ct. App. 1995), the court evaluated the Texas Disciplinary Rules of Professional Conduct in their analysis of a fee-splitting provision in a lawyer partnership agreement. Gray, a partner in a two-person firm, withdrew and a dispute arose over the distribution of fees earned and to be earned from personal injury cases taken by Gray. There, the court cited Rule 5.06 of the Disciplinary Rules and Opinion 459 of the Texas Commission of Professional Ethics (1988) and, as in Whiteside, found no question that the partnership agreement was counter to the rule and opinion of the Ethics Committee. However, the court further found that the ethics opinion, "in an effort to be fair to the withdrawing attorney, is not mindful of the rights of the firm or attorney remaining." Id. at 752. The court concluded that under the circumstances of the case, a violation of the Ethics Committee's opinion "[was] not contrary to public policy and should not be used as a procedural weapon." Id. at 753. On this basis, the clause was found to be enforceable.

In Noteboom: A Dramatic Deviation from Texas' Stand Against Non-Competition Clauses Among Lawyers, Jennifer Turner notes that the [Gray] decision is "surprising not only because it goes against the majority of other states, Ethics Opinion 459, and Texas jurisprudence regarding these restrictive covenants, but also because it does not address the principal policy reason against enforcing these agreements." Jennifer Turner, Noteboom: A Dramatic Deviation from Texas' Stand Against Non-Competition Clauses Among Lawyers, 58 Baylor L. Rev. 1011, 1024 (2006). This seems to be reflective of a trend wherein courts may be inclined to forgo the majority rule outlined in Whiteside, moving instead toward the minority positions outlined in Howard v. Babcock, P.2d 150 (Cal. 1993) and Fearnow v. Ridenour, P.3d 723 (Ariz. 2006), in their evaluation of employment agreements between lawyers, focusing more on a test of reasonableness than one of per se invalidity.

B. MINORITY RULE: Reasonableness Test

Contrary to holdings in Whiteside, Jacobs, and Cohen, wherein non-compete covenants were deemed per se invalid, other courts have applied a reasonableness test to such covenants. The California Supreme Court, ruling in Howard v. Babcock, P.2d 150 (Cal. 1993), held that "an agreement imposing a reasonable cost on departing partners who compete with the firm in a limited area is enforceable." Id. at 160. There, partners in a firm executed a partnership agreement under which any partner that withdrew from the firm prior to the age of retirement and thereafter went into practice in the same area of liability insurance defense work within the same court system would be subject to "forfeiture of all their rights to withdrawal benefits other than capital . . ." Id. at 412. The court held that changes in the practice of law require firms to protect their economic interests and that there is no "legal justification for treating partners in law firms differently . . ." Id. at 421. The court specifically rejected the idea of client choice as justification for the majority opinion holding non-compete clauses unenforceable, holding instead that noncompetition agreements should be evaluated under the common law "rule of reason" test, under which "a restraint against competition was valid to the extent reasonably necessary for the protection of the covenantee." Id. at 416. The court went on to explain that an absolute ban on competition would obviously be per se unreasonable, but "to the extent that [it] merely assesses a toll on competition within a specified geographical area . . . it may be reasonable." Id. at 425.

Further, in Fearnow v. Ridenour, P.3d 723 (Ariz. 2006), the court held that restrictive covenants were not per se invalid. Rather, they should be evaluated under law governing restrictive covenants in agreements between non-lawyers. Fearnow, who had paid for a share of stock in the partnership, withdrew from the firm and was required to tender back his stock shares to the firm for no compensation if he were to practice in the geographic area for more than ten hours per week. The court held that such an agreement amongst lawyers should be evaluated on the basis of reasonableness, citing the subject matter, type of business, locations, purpose of the restriction, and intention of the parties as factors for consideration. The court noted that ethics rules and opinions of the American Bar Association address agreements that restrict a lawyer's right to practice or compete, but not those that merely provide a financial disincentive, such as that in Fearnow's agreement. It reasoned that "the language of [Ethics Rule] 5.6 does not support . . . special treatment of lawyers, nor does protection of clients mandate such a result." Id. at 30. "Were Fearnow not an attorney," the court explained, "the voluntary withdrawal provisions would be subject to a fact-based reasonableness analysis." Id. at 27. Thus, the court held that a clause merely imposing a financial disincentive for withdrawal cannot be deemed per se unenforceable and must instead be submitted to a fact-based reasonableness test.

I. Reasonableness under Texas Business & Commerce Code

The Texas Supreme Court noted in Desantis v. Wackenhut Corp. that "an agreement not to compete is in restraint of trade and therefore unenforceable on grounds of public policy unless it is reasonable," and such an agreement is not a reasonable restraint of trade unless it meets each of three criteria." Desantis v. Wackenhut Corp., 793 S.W.2d 670, 681 (Tex. 1990). The court went on to note that the non-compete agreement must be "[1] ancillary to an otherwise valid transaction or relationship, . . . [2] must not be greater than necessary to protect the promisee's legitimate interest, . . . and [3] the promisee's need for protection must not be outweighed by either the hardship to the promisor or any injury likely to the public." Id. at 682. The court's assessment of a non-compete clause in a partnership agreement (such as the example given earlier) must satisfy each of these criteria to be deemed reasonable. Further, under Texas Business & Commerce Code § 15.50, if a covenant is found to be "ancillary to or part of an otherwise enforceable agreement at the time the agreement is made," it will be deemed reasonable to the extent that restrictions on time, geographical area, and scope of activity to be restrained are not greater than is "necessary to protect the goodwill or other business interest of the promisee." Tex. Bus. & Com. Code §15.50.

(i) Time Limitation

Pursuant to Tex. Bus. & Com. Code § 15.50, limitations as to time within a covenant not to compete must be reasonable. Our non-compete Clause makes no mention of a fixed time limitation relative to the attorney's practice of law, the agreement must be evaluated against those of similar circumstances. In addition, because Tex. Bus. & Com. Code § 15.51 provides for reformation of limitations contained in a covenant as to time, geographical activity, and scope of activity to be restrained, an agreement should also be assessed against those where the reasonableness of a particular time limit has been evaluated in the event that the court moves to reform the agreement.

In Oliver v. Rogers, 976 S.W. 2d 792 (Tex. App. 1998), Rogers and Rogers, doing business as Texas State Optical, agreed to sell one of their optometry clinics. As a provision to the sale of the clinic, it was agreed that so long as purchasers Oliver and Parker were not in default as to conditions of the sales contract, the Rogers would not open a competing practice, nor would they license one within a particular geographic area, making no mention as to the duration of such restriction. There, the court held that, while the duration of a covenant is a determinant in evaluating a covenant for reasonableness, ". . . the lack of a fixed time limitation cannot, in and of itself, render a covenant unreasonable." Id. at 800. Instead, the court reasoned, when a covenant lacks a fixed time limitation, it must be evaluated relative to restraints on geographic space and scope of activity before it can be deemed unreasonable.

On the other hand, the Court of Appeals held in Ray & Sons v. Stroman, 923 S.W.2d 80 (Tex. App. 1996), that unlimited duration of a non-compete clause was unenforceable. Stroman, an employee of family-owned insurance agency Ray & Sons, entered into a noncompetition agreement which provided restraints of time, geography, and scope of activity on Stroman's freedom to engage in insurance-related business. In analyzing the agreement, the court noted that it was unlimited as to time and, therefore, an "unreasonable restraint on trade" beyond the scope of what was necessary to protect the goodwill or business interests of the company. Id. at 85. While reformation of the unlimited provision was a possibility, the court denied Ray & Sons request for reformation, holding that they had "failed to show what, if any, reformation of the covenant would be reasonable and necessary to protect the goodwill or other business interests of the company." Id. at 85. Based on the opinion of the Ray & Sons court, it is likely the court will deem the non-compete clauses partnership agreement unreasonable due to the lack of a specified time restraint. Similarly, unless the Firm proposes a reasonable modification to the clause, the court is unlikely to offer reformation as a remedy.

Reformation of the Clause (amending the Clause with a time restraint) remains a possibility, however, courts will probably look to cases where time limitations have been deemed reasonable in order to evaluate how to reform the Clause in this instance. In Sheshunoff Mgmt. v. Johnson, 209 S.W.3d 644 (Tex. 2006), the Supreme Court of Texas held that a covenant not to compete requiring the employee to abide by restrictions to his consulting services while employed and for a period of one year following termination of his employment was reasonable. Id. at 656. The court noted that, in addition to other elements of the covenant, the one-year limitation was not greater than necessary to protect the goodwill or business interests of the employer. Id. at 657. Based on this holding by the Supreme Court of Texas, should the Firm seek to reform the non-compete Clause of the partnership agreement to reflect an explicit time limitation, it is evident that the court will likely consider a one-year restriction reasonable.

Teel v. Hospital Partners of America, 2008 U.S. Dist. LEXIS 8679 (S.D. Tex. 2008) provides insight as to the outer limits that the court may deem reasonable in reforming the non-compete clause in the situation of our hypothetical. There, Teel, who was chief executive officer of a Houston medical center, signed a non-compete agreement under which he was restrained from "owning, acquiring, developing, or managing a competing hospital . . . for one year after his (HPA) employment ended." Id. at 2. The District Court of the Southern District of Texas held that "the one-year period in the covenant falls well within the established parameters for reasonable noncompetition covenants in North Carolina." Id. at 13. The court went on to note that North Carolina courts have considered restrictions of up to five years as the "outer boundary [of what is] reasonable." Id. at 13. In evaluating the reasonableness of a time limitation, however, the court states, "The time and geographic limitations of a noncompetition covenant must be considered in tandem, 'such that a longer period of time is acceptable where the geographic restriction is relatively small, and vice versa.'" Id. at 12 (citing Okuma Am. Corp. v. Bowers, 638 S.E.2d 617, 620 (N.C. Ct. App. 2007). Thus, when considering possible reform of the unlimited time provision in the non-compete Clause, the court is likely to evaluate the geographical limitation simultaneously.

(ii) Geographic Limitation

As outlined in Tex. Bus. & Com. Code § 15.50, the limitation on geographical area contained in a covenant not to compete will be evaluated in an assessment of reasonableness. Under Tex. Bus. & Com. Code § 15.51, offending limitations can be reformed to impose a restraint not greater than necessary to protect the goodwill and other business interest of the promisee.

Zep Mfg. Co. v. Gregory B. Harthcock & Panther Indus., 824 S.W. 2d 654 (Tex. App. 1992) establishes a test for reasonableness of geographical limitations. Harthcock, a chemist, was hired by Zep and subsequently signed an employment agreement under which he agreed that he would not perform similar services to those performed at Zep for a period of twenty-four months following the termination of his employment. Zep asserted that the agreement contained "reasonable geographic limitations of "within a 100-mile radius of DeSoto, Texas," which could be inferred from evaluation of outside evidence. Id. at 660. The court, unconvinced, held that the agreement was silent on geographic limitation and, thus, unreasonable under Tex. Bus. & Com. Code § 15.50(2). The court did state, however, "We recognize that what constitutes a reasonable area generally is considered to be the territory in which the employee worked while in the employment of his employer." Id. Unlike Zep, the non-compete Clause (in our hypothetical partnership agreement) is explicit in its geographical limitations; following the withdrawal, the attorney is restricted from practice within the counties of El Paso, Hudspeth, Culberson, Jeff Davis, Presidio, and Brewster. Based on the court's assertion in Zep, it is likely that this will be deemed an unreasonable restriction, as the Clause has worked almost exclusively for clients in El Paso County. Under Tex. Bus. & Com. Code § 15.51, it is possible that the court would reform this overly broad restriction such that the attorney would be able to practice in Presidio County if he/she can provide evidence to confirm that he/she has not worked there while employed by the Firm.

Similarly, in Butler v. Arrow Mirror & Glass, Inc., 51 S.W.3d 787 (Tex. App. 2001), the court noted that a covenant not to compete with a broad geographical scope is unenforceable, "particularly when no evidence establishes the employee actually worked in all areas covered by the covenant." Id. at 794. There, Arrow, a fabricator of mirrors and stalls, hired Butler as its Operations Manager. Butler's employment agreement included a non-competition clause, which restricted him from engaging in "'same or similar type of business . . . in seven counties within the Houston metropolitan area and in any other area where Arrow began doing business during the term of Butler's employment." Id. at 790. The court found the geographical limitation as written to be overly broad, but reformed the limitation to reflect only counties with which Butler had substantial contact while employed with Arrow, noting that "Texas courts have usually reformed the covenant, revising the provisions to those which are reasonable under the circumstances." Id. at 794. On the basis of Butler, it is likely that the court would reform the geographical limitation in the employment agreement based on the activities of the attorney while with the Firm. The court is apt to maintain the restriction to practice within El Paso County, assuming this is where the majority of the attorney's from the firm are based. It is likely, however, that Presidio County can be blue-lined from the clause, assuming the attorney has never represented a client from there during her employment witht the firm and, asserting the Firm has few, if any, clients within that county. In such circumstances, the firm would have a hard time holding a logical/reasonable argument as of why the attorney should be banned from practicing in a jurisdiction where the firm does not represent any clients.

(iii) Scope of Activity Limitation

Pursuant to Tex. Bus. & Com. Code §15.50, the Court will also evaluate the non-compete Clause on the basis of its restraint on activity. The Supreme Court of Texas addressed this issue in its ruling in Peat Marwick Main & Co. v. Haass, 818 S.W.2d 381 (Tex. 1991). There, Haass, a partner in an accounting firm, left the firm after becoming disenchanted with developments within the recently merged company. Shortly after his resignation, Haass and other resigning employees opened a new accounting firm and secured the business of some of the former firm's clients. Pursuant to the partnership agreement Haass had signed previously, he was bound to compensate the firm for any solicitation or service of the firm's clients both while he was employed there and for a twenty-four month period following the termination. The agreement included "services provided directly or indirectly, as an individual, partnership, or corporation, engaged in the business of public accounting or any kind or character." Id. at 383. In evaluating the scope of this agreement, the court noted that the test turns on "requiring a connection between the personal involvement of the former firm member with the client acquired for reasonableness." Id. at 387. Citing Wisconsin Ice & Coal Co. v. Lueth, 250 N.W. 819, 820 (Wisc. 1933), the court continued, "[T]he restrictive covenant must bear some relation to the activities of the employee. It must not restrain his activities into a territory which his former work has not taken him . . ." Id. at 387. The court adds that inhibiting Haass from work with clients acquired after his departure is unnecessary. The provision is overbroad and unreasonable, it concludes. Id. at 388. Based on the holdings of the Haass court, it is likely that the court will find the restriction (in our hypothetical) on attorney's right to practice too broad, as it does not specify the area of law from which he/she is restricted, thus seeming to amount to an industry-wide exclusion. As it stands, the scope of activity from which the attorney is precluded would likely be deemed unnecessarily broad for protection of the Firm's business interests, especially assuming the attorney is seeking to represent immigrant workers in Presidio County, while the Firm has built its practice on the representation of employers seeking to obtain visas for their employees. This provision of the Clause could be reformed under Tex. Bus. & Com. Code § 15.51, provided the Firm could outline a specific business interest needing protection.

II. Reasonable Clauses

Courts may find the non-compete Clause, given it is reformed, to be per se invalid on the basis of its contradiction to public policy interests and ethical considerations. On the basis of these finding the non-compete clause per se invalid, overly broad, unreasonable, and, thus, unenforceable under Tex. Bus. & Com. Code § 15.50, the court will probably deem the voided clause as inseparable from the remaining partnership agreement, effectively prohibiting attorneys from collecting their withdrawal benefits. In Jacobs, the court held that "if striking the illegal portion defeats the primary purpose of the contract, we must deem the entire contract unenforceable." Jacob v. McLaughlin & Marcus, 128 N.J. 10, 33(N.J. 1992). The court would likely conclude, as it did in Whiteside, that the Firm's primary purpose for offering the withdrawal benefit was to restrict the attorney from practice such that their own interests would remain protected. On the basis that such a restriction is counter to public policy and the clause therefore invalid, the primary purpose of the contract will likely be defeated and the entire contract, including the withdrawal benefit, unenforceable as it stands.
Under Tex. Bus. & Com. Code § 15.51(c), however, the court may reform the agreement to be reasonable with respect to time and geographical locations, as well as limitations on scope of activity. Should the court undertake to reform the clause such that the limitations are reasonable and not greater than necessary to protect the goodwill or other business interests of the Firm, the covenant would be enforceable as reformed. The enforceable non-compete clause would then allow the attorney to collect the withdrawal benefit.

CONCLUSION

The non-compete Clause will likely be deemed either per se invalid, or unreasonable, and, thus, unenforceable on the basis of applicable case law and (Texas) state statute. Because the clause contravenes public policy and ethical considerations as outlined in Whiteside, Jacob, and Cohen, the court will likely rule the clause per se invalid. While the analysis of such non-compete clauses has developed beyond per se invalidity in the wake of Gray v. Noteboom, the clause will likely still be deemed unenforceable on the basis of its unreasonableness with respect to time, geography, and scope of activity, as outlined in Texas Business & Commercial Code § 15.50.

On the basis of this unreasonableness and unenforceability, it is extremely likely that the attorney will be able to leave his/her firm to start his/her own, say, immigration law practice in Marfa, Texas. Of particular importance to an attorney considering leaving her firm, Texas Business & Commercial Code § 15.51 allows the court to reform the offending provisions of the non-compete clause. While such reformation may ultimately make the clause enforceable, it remains unlikely that the attorney will be prohibited from starting her own practice in Marfa (assuming she desires to do so), as such restriction is beyond what the court is apt to deem necessary to protect the interests of the Firm. If the clause can be appropriately reformed such that it is deemed enforceable, it may still be possible for the attorney to collect her withdrawal benefit upon departing from her firm. In conclusion, with the analysis provided above, indirect non-compete clauses such as financial disincentives, are either held per se invalid under the majority rule, or unreasonable under the minority rule to the extent that it will not stand the degree of scrutiny courts place on such agreements.

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