01 / 06 / 2014

Protecting the Client Base

One of a business’s most valuable assets is its client base. This is particularly true of service-oriented and sales-oriented businesses. And a perennial problem for any business is the risk that trusted employees will depart, set up a competing business, and begin poaching clients. Covenants not to compete have been one method businesses have used to address this issue.

Covenants not to compete can be very effective when they prohibit solicitation of a business’s customers. Covenants not to compete have to meet strict requirements under Texas law to be enforceable, however, and a changing business environment can pose problems crafting such covenants so that they will remain enforceable in the face of changes. For example, the Internet has changed the playing field; even the smallest company can now compete “worldwide,” with a scattering of customers across several states or even national boundaries. A small business located in Texas may easily have a handful of clients in each of several other states or countries. The possibility that an employee who deals with those clients on a regular basis may depart and compete against the business for those customers is a real risk. A covenant not to compete reduces the risk significantly, but a poorly drafted one, especially with regard to its geographic restrictions, does not.

Under Texas’ Covenant Not to Compete Act, a fundamental requirement for an enforceable covenant is that it must contain limitations as to time, geographic area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than necessary to protect the employer’s goodwill or other business interest. Texas Courts have routinely struck down covenants not to compete that contain nationwide, worldwide, or, in a few circumstances, statewide geographic restrictions. How then, does a small business with small numbers of clients in different states or nations address the problem of properly limiting the geographic reach of a covenant not to compete without running afoul the Covenants Not to Compete Act’s strict requirements?

There are options. Several Texas courts have held that covenants not to compete limited to an employee’s clients or customers is a reasonable alternative to a geographical limit. These holdings grow out of earlier case law where Texas appellate courts upheld injunctions that enjoined defendants from doing business with their former employer’s customers. In the place of geographic limitations, those courts attached lists identifying specific customers defendants were not allowed to solicit or otherwise contact for business purposes. The rationale behind the cases is that by identifying specific clients or customers, a geographic limitation may be implied wherever that customer or client may be located. As one court expressed the problem, it is a matter of “how a reasonable geographic limitation is achieved.”

Thus, when drafting a Covenant Not To Compete, businesses may want to consider redefining or linking geographic limitations to identifiable clients or customers. Drafters may include a list identifying clients or customers by name and address, or may use a broader definition such as all clients or customers with whom the employee had dealt as of the date of the employee’s termination of employment. The advantage of agreements that substitute identifiable customers for a geographic restriction is that the circumscribed activity is limited and easily identifiable. The disadvantage is that, unless additional protections are incorporated into the covenant, the competing employee could quite literally set up shop next door to his former employer, so long as he did not solicit customer with whom he had dealt while working for his former employer.

Finally, covenants not to compete such as those described above are sometimes termed “non-solicitation agreements,” but the law does not distinguish between the two. A non-solicitation agreement is a covenant not to compete.

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