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Even Preparing To Compete In Texas May Be Prohibited During A Non-Competition Covenant Period

Posted in Non-Compete Enforceability, Practice & Procedure

Overview.  Nationsbuilders, an insurance underwriter, and two of its ex-employees executed a contract which contained a covenant barring the individuals, for one year, from competing with the underwriter or working for an “entity that conducts or plans to conduct a business that is in competition” with the underwriter.  The ex-employees used that year to prepare for the competition that would commence after 12 months.  The underwriter claimed that what they were doing violated the non-compete agreement, and a few days ago a Texas appellate court announced that it agrees.  Nationsbuilders Ins. Services, Inc. v. Houston Int’l Ins. Group, Ltd., No. 05-12-01103-CV (Tex. App., 7/3/13).

The “competition.”  While they were employed by Nationsbuilders, the individuals covenanted not to compete.  When they resigned and went to work for a competitor, Nationsbuilders complained.  Thereafter, the parties entered into a settlement agreement which contained a 12-month non-competition period.  During that year the ex-employees did not sell, quote or bind any insurance products in the relevant markets, but they did (a) send out marketing materials to potential clients, (b) prepare state agency regulatory filings, (c) develop underwriting guidelines, (d) draft policy and claim forms, and (e) conduct market research.  Nationsbuilders considered those activities to constitute a violation of the settlement agreement.

Arbitration.  The agreement provided for arbitration of any dispute, and so the underwriter filed a statement of claim alleging impairment of the “bargained for dormant period of non-competition.”  In response, the ex-employees denied that they were competing and asserted that, in any event, (a) Nationsbuilders’ contention that it had been damaged was hypothetical, and (b) the covenant was unenforceable for other reasons.    

The award.  The arbitrator sided with Nationsbuilders.  He ruled that the parties’ agreement entitled Nationsbuilders to a one year “dormant restricted period of non-competition, including the full extent of the no planning prohibitions.”  His award included a 12-month equitable extension of the non-compete covenant, and during that period the ex-employees were directed not to engage in “‘head start’ planning for competition.”  The settlement agreement provided for application of Delaware law.  Both that state and Texas permit equitable extension of a non-compete covenant. 

The arbitrator’s powers.  The ex-employees persuaded a Texas trial court to vacate the arbitration award, but the Texas Appellate Court recently reversed.  The Appellate Court stressed that the decision of an arbitrator must be upheld if its terms are rationally inferable from the parties’ contract.  The court found that the arbitrator’s award here drew “its essence” from the wording and purpose of the non-compete covenant.  The ex-employees maintained that the award was excessively vague because it did not state precisely what they are and what they are not permitted to do during the extension period.  The court disagreed and held that the award clearly prohibits conduct enabling them “to engage in ‘Competition’ after the restricted period sooner than they would be able without the conduct.”  The ex-employees queried whether all “passive contemplation” — such as internal and external communication, budgeting, and spending of money — is prohibited during the covenant period.  The appellate tribunal’s answer was that “passive contemplation” might “constitute a technical breach of the settlement agreement but ‘would not rise’ to the level of a material breach” unless it results in a “head start.”

Remand.  The Appellate Court observed that in the lower court the ex-employees had made two arguments not decided by the trial court.  They had maintained that the award (a) “serves as an unconscionable restraint on competition” because of the vast geographic expanse of the covenant, and (b) violated public policy by improperly interfering with their business despite the absence of any loss of customers or revenue to Nationsbuilders.  Neither argument was dealt with in the lower court’s decision, and so the cause was remanded for consideration of those arguments.

Takeaways.    The Appellate Court’s decision in Nationsbuilders could be viewed as a product of its own peculiar facts and circumstances which might seldom, if ever, recur.  Thus, the opinion might have little precedential significance.  On the other hand, it may be a harbinger of things to come.  The ruling may lead to development of a generalized legal principle that potentially penalizes virtually all preparation for competition during the non-compete period. 

A prohibition in a non-compete covenant of employment by an entity that conducts or plans to conduct business in competition with the former employer in the relevant market might at least discourage ex-employees from using the non-compete period to prepare for competition.  However, employers should recognize that, if litigation ensues, a court might conclude that the restriction is unduly vague or otherwise unenforceable.