Hunton Employment & Labor Law Perspectives : Employment Lawyers & Attorneys : Hunton & Williams Law Firm : Labor Law Legislative Updates

This issue landed before the Texas Supreme Court after Marsh & McLennan Companies, Inc. (MMC) filed suit against a former managing director, Rex Cook (Cook), who resigned from its subsidiary, Marsh USA, Inc. (Marsh).  Cook resigned from Marsh about three (3) years after he executed a non-solicitation agreement that contained confidentiality requirements as well as a restrictive covenant.  Marsh granted Cook the option to purchase stock if he signed the non-solicitation agreement.  The stock option program was designed to give certain choice employees the opportunity to become part owners of Marsh as well as motivate them to contribute to the company and benefit from the company’s long-term success.  

The trial court granted Cook’s motion for partial summary judgment ruling that the non-solicitation agreement was an unenforceable contract under Light v. Centel Cellular Co. of Texas, 883 S.W.2d 643, 647 (Tex. 1994), a case in which the Texas Supreme Court held that consideration for a non-compete agreement must give rise to “the employer’s interest in restraining the employee from competing.”  Marsh USA, Inc., 2011 WL 2517019 * 2, 7.  The Texas Court of Appeals agreed with the trial court, specifically “holding that the transfer of stock did not give rise to Marsh’s interest in restraining Cook from competing.”  Id. at 2.  The Supreme Court reversed the judgment of the Court of Appeals and remanded the dispute to the trial court for further proceedings.  Id. at 11.

Even though the CNCA was enacted to strike a balance between healthy competition in the market and reasonable covenants, judicial interpretations of the CNCA have not always fostered this goal.  Id. at 18.  For over a decade, courts have wrestled with the restrictive interpretation of the CNCA in Light.  Diverging from Light, the Marsh court ruled that goodwill is a protectable interest according to the express language of the CNCA and determined that Marsh “linked the interests of a key employee with the company’s long-term business interests” when it awarded Cook stock options.   Id. at 14.

The ruling in Marsh demonstrates an interest in enforcing the terms of the CNCA and its purpose, which was to “expand rather than restrict the enforceability of” non-compete agreements.  Id. at 9. The significance of the Marsh ruling is that stock options can satisfy the CNCA’s requirement that there be a nexus between a restrictive covenant and a protectable interest, including but not limited to, the goodwill of a business.

In general, the Act authorizes the enforcement of contracts that restrict competition, so long as they are reasonable in time, geographic area, and scope of prohibited activity.  One of the most significant ramifications of the Act is that it now permits “blue penciling” -- the ability of courts to modify or delete overbroad or invalid provisions, making the restrictive covenant enforceable.  This provision brings Georgia in line with a majority of other states that allow this type of judicial modification. 

Additionally, the Act expressly deems restrictive covenants with a duration of two years or less presumptively reasonable, and those attempting a longer duration presumptively unreasonable.  But the Act fails to include a similar “presumptively reasonable” time limitation for nondisclosure covenants.  Under the Act, nondisclosure agreements generally may last so long as the information remains “confidential” or a “trade secret.” 

As to geographic area, the Act does not require non-solicitation agreements to contain an express geographic definition.  This provision enables employers to enforce non-solicitation restrictions that lack an express reference to a specific territory or geographic area, and further allows that territory to include prospective customers.  Language prohibiting “soliciting or attempting to solicit business from customers” is defined to include those customers and prospective customers that the employee had material contact with, involving products and services that are competitive with the employer’s business.  

The new Act is not limited to the employment context, and has separate provisions specifically addressing restrictive covenants involving the sale of a business, distributors, dealers, franchisees, lessee’s of real property or personal property, and licensee’s of a trademark, trade dress, or service mark, as well.  For example, restrictive covenants in a sale of a business are presumptively reasonable for five years, or as long as payments are being made to the seller, whichever period is longer. 

These changes to Georgia law will most certainly result in increased enforcement of restrictive covenants in the Georgia courts in a variety of circumstances.  However, in analyzing all of the Act’s favorable provisions, it is important to understand that the Act still contains some limitations.  These new provisions apply only to contracts entered into on or after November 3, 2010, and prior agreements and contracts will be enforced under the former interpretive framework established by the courts.  Additionally, some of the key provisions related to employment apply only to (i) sales and business development professionals; (ii) managers or department heads; (iii) key employees; and (iv) “professionals,” as those terms are defined by the statute. 

In light of this new law, companies are encouraged to review and examine any “form” non-compete and non-solicitation agreements and purchase agreements, and evaluate whether revised agreements may be beneficial.

Facts Of The Case
 
H&R Block provides tax preparation and related services.  Between 2000 and 2005, H&R Block employed Morris as a seasonal tax preparer in Georgia.  In November 2004, Morris entered into an employment agreement with H&R Block that covered the 2005 tax season.  The agreement contained restrictive covenants, including noncompetition and nonsolicitation covenants. 

The noncompetition covenant extended for a two-year period following the expiration of Morris’s agreement or her resignation or termination.  It provided that “Associate shall not, directly or indirectly, provide any of the following services to any of the Company’s clients:  (i) prepare tax returns, (ii) file tax returns electronically, or (iii) provide any alternative or additional service or product that Associate provided or offered as an employee of the Company … The restrictions … are limited to (i) Associate’s district of employment, and (ii) a twenty-five (25) mile radius as measured from the office to which Associate is assigned.”
 
The nonsolicitation covenant extended for the same duration as the noncompetition provision and stated:  “Associate shall not, directly or indirectly, solicit or attempt to solicit any of the Company’s clients for the purpose of providing (i) tax return preparation, (ii) electronic filing of tax returns, or (iii) any alternative or additional service or product that Associate provided or offered as an employee of Company.”  The agreement defined Company clients to include people or entities with whom Morris had contact by providing services as an H&R Block employee.
 
Morris received a form letter from H&R Block on or about October 31, 2005 that welcomed her back to H&R Block and invited her to attend orientation for the 2006 tax season.  Morris attempted to attend the orientation, but alleged that she was prevented from doing so by one of H&R Block’s office managers.  The next day, the H&R Block manager in charge of the district where Morris worked informed her that H&R Block was performing an internal audit of the tax returns she prepared.  Morris later received a letter from H&R Block that she was ineligible for hire until the audit process was completed.  Eventually, in December 2005, H&R Block informed Morris that she was ineligible for hire. 
 
In January 2006, Morris opened her own tax preparation business with offices 13.3 miles from the H&R Block office where she worked.  During the 2006 tax season, Morris’s new company prepared tax returns for 87 former H&R Block clients.  Morris personally prepared 47 of these returns.  Morris claimed she did not solicit the business of H&R Block’s clients directly or indirectly. 
 
H&R Block filed suit against Morris on June 2, 2006, alleging that Morris violated the terms of her employment agreement by (1) soliciting H&R Block’s clients for the purpose of providing tax-preparation services, (2) providing tax preparation services for former H&R Block clients, and (3) soliciting and hiring H&R Block’s employees.  Ultimately, the United States District Court ruled in favor of Morris, finding that the noncompetition covenant was unenforceable because it prevented Morris from accepting unsolicited business from former clients.  The District Court also invalidated the nonsolicitation covenant.  The case was appealed to the Eleventh Circuit.

The Eleventh Circuit’s Decision and Reasoning

Under Georgia law, restrictive covenants in employment agreements are subject to strict scrutiny and will be enforced only if they are reasonable as to the duration, territorial coverage, and scope of activity of the covenant. 
 
The Eleventh Circuit determined that the District Court applied the wrong standard when reviewing the reasonableness of the noncompetition provision because it used a ruling involving a nonsolicitation covenant and not a noncompetition covenant.  After applying the correct standard, the Eleventh Circuit determined that the noncompetition covenant in Morris’s agreement was enforceable because it applied only to the district in which Morris worked and a 25-mile radius from the H&R Block office where she worked.  The Court opined that Morris had notice of the restriction because H&R Block disclosed and identified the territorial coverage of the covenant when it included a map illustrating the restricted geographic area in the agreement. 
 
Moreover, the Court determined the noncompetition covenant was enforceable because other courts had found that a two-year duration was reasonable.  In addition, the covenant was deemed sufficiently narrow because it only prohibited Morris from taking clients she serviced while employed by H&R Block in 2005.  Morris was not prohibited from preparing taxes or providing related services to the general public, or even to all H&R Block clients.
 
The Eleventh Circuit also determined that the nonsolicitation covenant was enforceable.  Specifically, the Court determined the covenant was reasonable in duration and activity restricted because Georgia courts have found a two-year duration to be reasonable and the covenant applied only to H&R Block clients who Morris served during the 2005 tax year.  Moreover, the covenant only prohibited Morris from initiating contact with H&R Block clients for the purpose of providing the services she previously provided for H&R Block.  The covenant did not prohibit Morris from accepting unsolicited business.
 
After finding that the noncompetition provision was enforceable, the Court determined that Morris violated the covenant because she prepared tax returns for 47 of H&R Block’s clients at a location that was less than 25 miles from the H&R Block office where Morris worked.  Accordingly, the Eleventh Circuit reversed the District Court’s decision denying H&R Block summary judgment.

What The Decision Means For Employers

Historically, restrictive covenants in employment agreements have been difficult for employers to enforce under Georgia law.  This decision offers more guidance on how to prepare noncompetition and nonsolicitation covenants that will be upheld in Georgia.  Any employer with a need for restrictive covenants to protect its business also must consider Georgia’s recently passed HB 173, codified at O.C.G.A. §§ 13-8-2.1 and 13-8-50 - 59.  Importantly, because Georgia’s Constitution prohibits contracts “in restraint of trade,” these statutory changes will not become effective unless the Constitution is amended in the upcoming general election in November 2010.  This area of Georgia law is dynamic, and companies that do not periodically review restrictive covenants within their operating and employment agreements increase the risk of unfair competition from departing employees.

Id. at *1.

This is a significant—albeit, arguably logical—extension of the Court’s ruling in Alex Sheshunoff Mgmt. Servs., L.P. v. Johnson, 209 S.W.3d 644, 649 (Tex. 2006), which held that a covenant not to compete is not unenforceable simply because the employer’s promise is executory when made.   

This case may indicate the beginning of a trend toward result-driven analysis—i.e. courts seem more willing to stretch an agreement in order to protect that which seems reasonably protectable, while disregarding the more stringent precedent that, historically, was tied to the plain language of the non-compete statute.  The practical result is that, in a post-Sheshunoff world, the line continues to be blurred, and it is becoming increasingly more difficult to determine whether an agreement that does not meet the traditional tenets of non-compete law may, ultimately, be deemed enforceable. 

Historically, while there was no explicit precedent on the matter, Georgia franchisors have acted under the assumption that in-term restraints would enjoy a more relaxed standard given the fiduciary and good-will dynamics at issue in an active franchise relationship.  Indeed, many Georgia franchisors have crafted in-term non-compete clauses that rely upon a more relaxed standard.  In Georgia, where the requirements for non-compete enforcement are more rigorous than those in most states, and blue-pencil revising currently is not authorized, many franchisors are left with likely unenforceable in-term non-compete provisions in current operating agreements.       

One of the troubling aspects of the decision is the Court’s failure to distinguish between a garden-variety employment relationship and an ongoing franchise relationship.  The latter is undertaken by a business owner who is bargaining for the right to borrow the valuable assets -- good will, marks, products, processes, and the like -- of the franchisor, in furtherance of his own private enterprise.  Most business owners and lawmakers would agree that the franchisee is not in need of (or entitled to) the same level of protection against unfair restraint of trade as is the average citizen employee.  It is this right to bargain for enhanced restrictions that encourages franchisors to offer more franchise opportunities, which stimulates enhanced economic activity.      

The legislature in Georgia has taken steps to bring enforceability to non-competition agreements.  In its Spring 2009 session, the Georgia General Assembly passed House Bill 173, which would dramatically change Georgia’s traditional hostility to covenants not to compete or solicit customers in favor of more consistent enforcement of such agreements.  However, because Georgia’s Constitution prohibits contracts “in restraint of trade,” the statute will not become effective unless the Constitution is amended in the general election in November 2010.

In the meantime, franchisors with operations in Georgia should consider revisiting any in-term non-competition clauses contained in their operating agreements, and revising them to bring them into compliance with the strict scrutiny standard applied in Georgia.