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.

David B. Willis

David B. Willis

Bryan Willis is a Tyler lawyer providing legal services across Texas in the areas of business law, litigation, probate, and estate planning.
David B. Willis

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