Category Archives: Recent Cases

Forfeiture Provision in Executive Bonus Compensation Incentive Program is Not a Covenant Not to Compete Under Texas Law

The Supreme Court of Texas issued its opinion in Exxon Mobil Corporation v. Drennen this past week considering whether New York choice-of-law provisions in a Texas based corporation’s executive bonus-compensation incentive programs are enforceable.  The Court’s decision ultimately turned on whether or not a forfeiture provision in those programs constituted a covenant not to compete under Texas law.

The programs provided that an employee would forfeit his outstanding awards if he engaged in “detrimental activity” or resigned.  “Detrimental activity” was defined by the programs to include becoming employed by an entity that regularly competed with the company.  After being informed that he would be replaced, the executive in this case resigned and later accepted employment with a competitor of the company.  Exxon then terminated his outstanding incentive awards under the detrimental activity provisions.  Drennen filed suit seeking a declaratory judgment that the detrimental activity provisions were being utilized as covenants not to compete, were unenforceable, and were an impermissible attempt to recover monetary damages for an alleged breach of such covenant.  The jury found in favor of Exxon, the court of appeals reversed and ordered the trial court to render judgment in favor of Drennen.

The Court’s Analysis

The Supreme Court’s analysis started with a consideration of whether the programs’ choice of law provisions selecting New York law were enforceable.  The court noted that Texas recognizes the party autonomy rule under which parties may agree to be governed by the law of another state.  The Court previously set forth the  framework for determining whether such a provision is enforceable in DeSantis v. Wachenhut Corp. which adopted Section 187 the Restatement (Second) of Conflict of Laws.

The Court found that under Section 187, the parties had a reasonable basis for choosing New York law, Texas had a more significant relationship to the transaction and the parties than New York, and Texas had a materially greater interest then New York in whether the agreement was enforced.  The Court’s analysis of whether the choice of law provision was enforceable then turned to whether or not the application of New York law would be contrary to a fundamental policy of Texas.

The Court noted that while it had not previously defined “fundamental policy,” it had determined that the law governing enforcement of non-competes was a fundamental policy of Texas in its DeSantis opinion.  The question in this case was whether or not Exxon’s incentive programs, and the forfeiture provisions specifically, constituted a covenant not to compete.  If the forfeiture provision was in fact a covenant not to compete, then enforcing the choice of law provision would implicate a fundamental policy of Texas and its law governing the enforcement of non-compete agreements.

In Marsh USA  Inc. v. Cook, the Court provided a general definition of a covenant not to compete as a covenant “that places limits on former employees’ professional mobility or restrict[s] their solicitation of the former employers’ customers and employees.”  The Court found that the restrictions in Exxon’s incentive plans did not fit this general definition because Drennen did not make a promise not to compete or to solicit customers or employees under the forfeiture provision.

The Court also identified a key difference between non-compete provisions and forfeiture provisions in that the former are designed to protect a company’s investment in its employee by restricting that employee’s post-employment activities while the latter are designed to promote loyalty through rewards without restricting an employee’s post-employment activities.  In this case Drennen did not promise to refrain from competing with Exxon, rather, he agreed to continued loyalty as a condition to the receipt of his outstanding bonus compensation.  Drennen was not prohibited by the agreement from any post-employment activities meaning that Exxon had no legal right to prohibit his employment with its competitor (at least not one that it tried to enforce).

Since the forfeiture provision was not a non-compete, and there was no other fundamental policy implicated by the provision, the Court found that enforcement of the New York choice of law provision would not contravene a fundamental policy of Texas.  The Court then applied New York law to the facts to determine that the New York’s “employee choice” doctrine applied and that the forfeiture clause should be enforced.

A Change In Texas Policy?

In its analysis of Texas’s public policy the Court noted a potential shift in Texas policy regarding the enforcement of Texas laws on companies operating in Texas and also the application of out of state laws under choice of law provisions in Texas.  I’ve excerpted the language below:

With Texas now hosting many of the world’s largest corporations, our public policy has shifted from a patriarchal one in which we valued uniform treatment of Texas employees from one employer to the next above all else, to one in which we also value the ability of a company to maintain uniformity in its employment contracts across all employees, whether the individual employees reside in Texas or New York.

This appears to be a signal from the judiciary that as Texas continues to grow as a business friendly state and as businesses continue to move to the state, the state’s courts will be increasingly willing to forgo a strict application of Texas laws to those companies.  The courts will allow companies based in Texas to elect to have their employment agreements governed by laws from other states even when those agreements are with Texas based employees.

5th Circuit Says Court Cannot Force a Party to Pay Arbitration Fees and Why Arbitration Is Not Always The Best Option

You have to wonder if this recent ruling might cause some companies to pause over the recent craze to automatically include arbitration clauses in their contracts.

In Dealer Computer Svc v. Old Colony Motors the 5th Circuit ruled that a trial court did not have the authority to compel a party to pay an arbitration deposit.  The underlying dispute is not important for this post.   Neither party disputed the existence and validity of an arbitration clause in the contract.  That arbitration clause specified that the AAA Commercial arbitration Rules would govern any dispute.

The issue was Old Colony’s inability to pay its portion of the arbitration deposit.  Old Colony was still willing to arbitrate but it could not pay its portion of the fees involved.  As a result, the arbitrator asked Dealer Computer to pay the entire fee.  Dealer Computer refused and the arbitrator suspended the matter indefinitely.   Dealer Computer filed suit to compel the arbitration and the trial court ordered Old Colony to pay its share of the deposit.

On appeal, the Court agreed with Old Colony’s argument that the trial court did not have the authority to order it to pay those fees.  The key to its decision is that the Supreme Court has stated, “absent an agreement to the contrary, the parties intend that the arbitrator, not the courts, should decide certain procedural questions which grow out of the dispute and bear on its final disposition.”  Payment of fees is just such a procedural question.

The Court turned to a 9th Circuit case, Lifescan, Inc. v. Premier Diabetic Servs., Inc. in support of its ruling.  In that case the 9th Circuit noted that arbitrators have the discretion to require fee deposits and could change those rules to require one party to pay the deposit if they choose.  Such a decision was entirely a procedural matter and not subject to a court order.

The Court also noted that AAA rules allowed arbitrators the discretion to order either party to pay the fee in full and to suspend or terminate the arbitration if those fees are not paid.  Any award could be adjusted upward or downward as appropriate if one party paid more than its fair share of the fees involved. The Court specifically avoided deciding whether a party could challenge an arbitrator’s decision if they did not adjust the award.

So why would this decision cause a company to rethink an automatic commitment to arbitration?

First, expenses.  The commonly misunderstood belief is that arbitration is a cheaper alternative to the court system.  But look at this case, the arbitrator’s deposit was in excess of $50,000.  Dealer Computer was asked to pay Old Colony’s portion of $26,000 as well as its own just to get the case before an arbitrator with no guarantee of success.  The fees to file suit in court are no where near this amount.  A company has to pay attorney’s fees in both cases.  If Dealer Computer had filed suit and Old Colony could not afford legal counsel, Dealer Service’s attorney’s fees would likely be minimal and the case would end relatively quickly.

Second, collectibility.  Now this is an issue in any dispute: does the other party have the assets available to satisfy a judgment?  But in this case Dealer Computer has to double down on its filing fees. If it wins in arbitration and if those additional fees are part of the award, it won’t matter one bit if it can’t collect.  Dealer Service will have just thrown good money after bad.

Third, indefinite delay.  Is it possible that Dealer Computer could never get its day before a decider of fact?  Because there is an arbitration clause, a Court cannot order Old Colony to pay its share of the fees.  Because there is an arbitration clause, Dealer Computer cannot bring suit in court.  As long as Old Colony does not pay its share, Dealer Computer’s only option is to shoulder the costs and risks involved by paying both parties’ fees.  If the merits of the case are a close call, say a 55/45 deal(or even 60/40) in Dealer Computer’s favor it might not be worth it.  A party could escape its liabilities by simply stating it is willing to participate in arbitration but then refusing to pay its share of the fees.

What does the New Haven case mean for private employers?

The short answer is not a whole lot.  This case does not provide a good guide for private employers because it involved the City of New Haven, a government entity.  Government entities at both the federal and state level must abide by stricter rules than private employers.

However there is an important lesson that any employer should take away from this case: you cannot throw out the results of an employment test because the results end up favoring a particular race.  Why? Because that very act means that the employer is making an employment decision based upon race.

This of course presents the damned-if-you-do, damned-if-you-don’t problem for an employer.  If the employer strikes the results, they risk a law suit.  Indeed I would expect to see a rise in these “reverse discrimination” type law suits after the New Haven case.  Alternatively, if the employer upholds the results of such a test then they face litigation over the results favoring one race or another.

So what does this mean for employers? The first choice is to avoid employment tests whenever possible.  If you do choose to give tests, make sure there is a legitimate need for a test specific to the position you are testing for.  Designing the test is critical.  You must make sure every question has a legitimate purpose in evaluating a candidate for the position.  Document the reason every question exists in the test and the purpose for which it is asked.

If you take these steps, then live with the results.  As the Supreme Court noted, just because you might be sued based upon the results it does not mean that the law suit will be successful.  Thus, the steps employers take in designing and documenting the process of creating the test are even more critical after this decision and that is the real lesson.