Texas court holds employee’s non-compete agreement invalid and unenforceable

IMG_2095A computer software company sued one of its former employees in Texas for breach of a non-compete agreement after the employee went to work for a competing software company.  Trilogy Software, Inc. v. Callidus Software, Inc., 143 S.W.3d 452, 457 (Tex. App. –Austin, 2004).  Trilogy, the former employer, required Yinghui Liu, a computer programmer and technical consultant, to sign a non-disclosure and non-compete agreement at the time Trilogy hired Liu.  The Agreement stated that Liu would receive confidential business information from Trilogy as part of his training; Liu promised in writing not to share this information with persons outside of Trilogy.  In addition, Liu promised not to work for any of Liu’s competitors for two years after leaving Trilogy.

Approximately four years later, Trilogy laid Liu off due to lack of work.  At the time that Trilogy let Liu go, Trilogy asked Liu to sign a separation agreement.  In the separation agreement, Liu again pledged to honor the non-disclosure and non-compete agreements that he had signed when hired.  In return, the separation agreement gave Liu one month’s salary and allowed Liu to stay on the Trilogy payroll for a month to assist Liu with his immigration status.

Once he was laid off, Liu went to work for Callidus, a competitor of Trilogy.  Trilogy sued Liu for breach of the non-compete agreement, because Liu worked for a competitor in violation of the agreement.  Trilogy also sued Liu for breach of the non-disclosure agreement, claiming that Liu had given Callidus some of Trilogy’s confidential information related to Trilogy’s products.  Trilogy also sued Callidus for unlawfully interfering with Liu and Trilogy’s agreements, and for unlawfully taking Trilogy’s trade secrets.

The Court’s Ruling

The district court held, and the court of appeals affirmed, that Trilogy’s non-compete agreement with Liu was invalid and unenforceable.  Trilogy at 462-463.  The court held that because Trilogy did not give Liu the confidential business information at the same time that Liu signed the non-compete, the confidential information did not “give rise to the employer’s interest in restraining the employee from competing” and therefore the non-compete and the confidential information were not sufficiently related to each other.  Id.  The court held that the one month severance pay was not the type of benefit which can constitute “consideration” for a non-compete agreement.  Id.  Thus, Liu was not bound by the non-compete agreement because Liu did not receive anything from Trilogy which justified enforcement of the non-compete agreement.  Id.

However, the court of appeals did restore Trilogy’s claim for breach of the non-disclosure agreement, reversing part of the district court’s decision.  The court of appeals said that while the non-compete agreement required contemporaneous provision of the confidential information to be enforceable, the non-disclosure agreement did not.  The non-disclosure agreement was signed before Trilogy provided any confidential information, and was not immediately enforceable as a result.  However, once Trilogy provided the confidential business information that it promised, the non-disclosure agreement became binding.

Lessons from the Case

The Trilogy case holds several lessons for the employer who wishes to protect itself from employees leaving to join a competitor.  Conversely, the case has lessons for an employee who is contemplating moving to a competing business.

First, an employee’s agreement not to work for a competitor is generally not enforceable unless the employee has received confidential business information, because a non-compete agreement is only enforceable when it is necessary to protect such information.  An employer cannot simply buy a non-compete agreement with a cash severance package, post-termination benefits, etc.

Second, an employee must receive confidential business information at the time of forming a non-compete agreement, in order for the agreement to be enforceable.  If the employee receives the information a significant amount of time before or after agreeing to the non-compete, this can be a basis for invalidating the non-compete agreement.  The court of appeals in Trilogy held that when Liu first signed the non-compete, he did not have any confidential business information, and when he re-signed it at his termination, he had already had the information for some time.  At both occasions, the non-compete was unenforceable.  As the court of appeals explained, one reason that the courts are so strict and particular about the proper way to form a non-compete agreement is that these agreements restrain trade and so are disfavored by the law.  Trilogy at 459.

Third, a non-disclosure agreement may have a better chance of standing up in court than a non-compete agreement, and may be simpler for the employer to implement, because the non-disclosure agreement can be signed at the time that the employee is hired, and become binding once the promised confidential business information is given.

As for the question of what is confidential business information and what is not, we will leave this for another day.  Texas has recently codified its law of trade secrets by adopting the Texas Uniform Trade Secrets Act (TUTSA).  This will deserve study in future articles.

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