On the eve of celebrating our nation’s independence and hence, presumably preparing for the fireworks to follow the next day, the Court of Appeals for the Fifth District of Texas at Dallas issued a ruling in Nationbuilders Insurance Services, Inc. v. Houston International Insurance Company, Ltd., 2013 WL 3423755 (Tex. App. – Dallas, Jul. 3), confirming that an arbitrator had the authority to grant a one-year extension of a non-compete agreement which prohibited insurance executives from planning a business competing with their former employer  . . . and consequently, reminding folks that you don’t mess with Texas.

Kevin Cunningham and Michael Leamanczyk became employed with Nationbuilders Insurance Services, Inc. (“Nationbuilders”) in 2006, and in conjunction therewith, each signed a non-compete agreement. When Cunningham and Leamanczyk left Nationbuilders in 2010 to work for another insurance group, Nationbuilders filed suit against them. The litigation was resolved via a May 4, 2011 settlement agreement (“the Agreement”) which restricted the men from “engaging in Competition” with Nationbuilders from May 4, 2011 through May 4, 2012.  “Competition” was defined, in pertinent part, as “plan[ning] to conduct” a competing insurance business. The parties to the Agreement consented to the application of Delaware law to govern any disputes, which disputes also would be arbitrated.

During the restricted period of competition, Cunningham and Leamanczyk began planning and preparing to sell competing insurance. For example, they marketed their new business, prepared regulatory filings, and developed underwriting guidelines. Not surprisingly, in January 2012, Nationbuilders filed an arbitration demand claiming that Cunningham and Leamanczyk were in violation of the Agreement.

After the arbitration hearing concluded on April 27, 2012, the arbitrator issued a May 31, 2012 award in Nationbuilders’ favor. The arbitrator concluded that as the two men had planned a competing business during the “dormant period,” they had breached the Agreement such that Nationbuilders should “be restored the benefit of the bargain it made pursuant to the May 4, 2011 settlement agreement.” The arbitrator awarded Nationbuilders an equitable extension of the non-compete agreement for one-year, effective May 5, 2012 through May 5, 2013.  Cunningham and Leamanczyk thereafter obtained an award from the trial court on grounds that the arbitrator went beyond the scope of his authority in fashioning the equitable remedy.  Specifically, the trial court vacated the award under Section 10(a) of the Federal Arbitration Act providing that arbitration awards can be vacated “where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.”  9 U.S.C. Section 10(a).  Nationbuilders appealed.

On appeal, as the men did not dispute that they had, in fact, breached the Agreement by planning a competing business during the restricted period, the Court noted that the only question to be answered in considering whether the award was appropriately vacated under Section 10(a) as a result of the arbitrator exceeding his powers “was whether the award . . . is rationally inferable from the contract.” In concluding that the arbitrator’s award was appropriately issued, the Court noted that the arbitrator simply required the parties to abide by the Agreement – in other words, that Cunningham and Leamanczyk refrain from planning a competing business for one year.  Further, despite Cunningham and Leamanczyk’s arguments to the contrary, the Court held that the arbitrator – although having issued the arbitration award after the restricted period had expired – had not ruled on a moot issue. Though the men argued that enforcement of the restricted period became moot after it expired on May 4, 2012 such that the arbitrator had no jurisdiction to enjoin their competing conduct, the Court differentiated specific performance  – providing that a non-compete enforcement is moot after the contractual period of the covenant expires – from equitable extension, where the award was simply an extension of the restricted period under the arbitrator’s power of equity. As both Delaware and Texas law allowed for equitable extension, the Court concluded that the arbitrator’s decision was in line with the choice of law provision in the Agreement and not in contravention of Texas public policy.

Though the Court reversed the trial court’s ruling vacating the arbitration award, it declined to render judgment in Nationbuilders’ favor confirming the arbitration award or remand the matter to the trial court to confirm the award.  In doing so, the Court noted that the trial court had not addressed Cunningham and Leamanczyk’s two alternative public policy arguments for vacation of the award: (1) whether the award violated public policy by effectively allowing Nationbuilders “up to four years of freedom from competition in an unrestricted geographic location;” and (2) whether the award violated public policy by improperly interfering with their business where Nationbuilders had not suffered any loss of customers or revenue. (Notably, the parties did not address the fact that by the time of the Court’s ruling on July 3, 2013, the equitable extension of the restricted period had expired; thus the Court declined to address that issue).

The take away from Nationbuilders is threefold. First, a non-compete agreement which includes an arbitration clause should specifically outline the penalties for violation of the agreement in the agreement itself. Where an arbitrator disregards the express penalty provisions of a non-compete agreement which were mutually agreed upon by the parties and reduced to writing in the non-compete agreement, an arbitrator very likely will exceed his equitable powers by fashioning alternate remedies. The Agreement in Nationbuilders contained no penalty provisions, hence the arbitrator was within his discretion to fashion an equitable remedy which gave effect to the purpose of the Agreement. Prudence similarly suggests that all non-compete agreements, even those not containing arbitration clauses, should outline the penalties for a breach.

Second, parties should be cognizant of the choice of law provisions in any non-compete agreement. Had the Agreement in Nationbuilders been subject to Louisiana or Massachusetts law where equitable extension is not allowed, for example, the Court presumably would have refused to allow the arbitrator to equitably extend the restricted period.

Third, Nationbuilders reminds us that parties to a non-compete agreement should consider whether it is wise to mess with a Texas arbitrator’s equitable powers.

If you would like additional information on non-compete agreements and trade secrets law, please contact one of the Burr & Forman Non-Compete & Trade Secrets team members.