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Restrictive Covenants: A Cautionary Tale

Wednesday, 20 August 2014 19:08 Written by  Michael Klimpl

A recurring issue employers must address is the enforceability of restrictive covenants entered into with an employee. These restrictive covenants are typically non-disclosure (confidentiality), non-solicitation, and/or non-competition agreements.   The timing, form, and substance of these agreements will determine whether a court will find them valid. From a former employee’s perspective, the issue is basically the same but reversed: can the employee disregard a previously signed restrictive covenant without being liable for monetary damages to his former employer (and if newly employed at another company, keeping the second company out of litigation)?

Two cases recently decided by the Pennsylvania Superior Court provide guidance for employers and employees:

Fleisher v. Bergman, concerned an employee who was hired as a full-time employee. At the time of his hire, employee signed a restrictive covenant which was a confidentiality and non-competition agreement. The restrictive covenant provided that employee would not divulge any “Confidential Information” (e.g., customer lists, pricing policies, names of vendors) to other parties without the consent of employer; the Agreement further mandated that for a period of five years after termination of his employment, employee would not “. . . solicit or do business with any . . . entity . . . that was, within the three year period preceding the Employee’s termination, a Client or Prospect of Employer... ”

After employee had worked for over six years, employer discovered that employee had been soliciting business for the clients and prospects of employer and trading in his own name. Employee’s business was in direct competition. As a result, employer terminated employee, brought suit in the lower court, and was granted a preliminary injunction barring employee from soliciting for five years any entity that was a client of employer for the previous three years.

In affirming the lower court’s grant of the injunction, the Pennsylvania Superior Court concluded that the injunction, while not restricted to a geographical area, was not overbroad because it only applied to soliciting employer’s clients. Employee could therefore work in direct competition with employer (without soliciting employer’s clients).

Secondly, the Superior Court rejected employee’s claim that because he had become a part-time employee during his tenure with employer and at that point received none of the benefits of a full-time employee, employer had therefore not provided adequate consideration (that is payment of money or some other bargained benefit such as a job promotion) for the restrictive covenant. The Court, noting the general rule that a restrictive covenant is not enforceable unless an employee received consideration for signing it, found that in this case, the restrictive covenant was enforceable. Specifically, the restrictive covenant had been signed at the time the employee entered into his employment and as an express condition of such employment. The fact that the employee subsequently voluntarily decided to become a part-time employee was not relevant.

In Socko v. Mid-Atlantic Systems of CPA, Inc., the Superior Court was faced with the novel (for Pennsylvania) question of whether a non-competition covenant in an employment agreement is enforceable where the agreement was signed after the commencement of employment and the employee received no monetary benefit or change in job status. Instead, the agreement contained the words “intending to be legally bound”. To resolve the case, the Court had to consider two seemingly conflicting principles of Pennsylvania law.  

The first is the general rule that for a contract between two parties to be enforceable, it must provide some type of consideration for each party. However the adequacy of the consideration is not generally considered by a court in determining the validity of the contract.  In fact, under the Pennsylvania Uniform Written Obligations Act, a contract is enforceable even if no tangible benefit is bestowed on one of the parties so long as the words “intending to be legally bound” appear in the contract.

However, with respect to restrictive covenants, which are generally disfavored by Pennsylvania Courts, the rule is that a restrictive covenant entered into with an employee subsequent to the employee’s hiring must provide adequate consideration to be enforceable. For instance, the continued employment of an at-will employee is not adequate consideration. A payment of more than a nominal sum or a job promotion, depending on the specific facts, could qualify as adequate consideration.

In Socko, the Court resolved this issue by ruling that the words “intending to be legally bound”, while sufficient in other contexts, do not provide adequate consideration for a restrictive covenant signed by an employee after commencement of employment. Some type of tangible benefit (e.g. payment of money, or job promotion) must be furnished to the employee.

These two cases are a clear statement of Pennsylvania law regarding restrictive covenants. It must be emphasized that the laws of each state vary according to the statutes and court decisions of each state. The cases discussed above would therefore not be applicable in, for instance, New Jersey.  

A restrictive covenant entered into at the time of employment may be enforced if a court determines it is reasonably necessary to protect the interest of an employer and the restrictions imposed are reasonably limited in scope-both in duration and geographic reach. To the contrary, restrictive covenants entered into some time after the commencement of employment, without any additional and adequate consideration, will not be enforceable. As noted above, timing, form, and substance are critical.

Last modified on Monday, 11 May 2015 16:41
Michael Klimpl

Michael Klimpl

Michael’s practice areas include Real Estate, Municipal Law, Zoning and Land Use, Employment Law, Civil Litigation, Estate Planning and Estate Administration, with a concentration in the areas of employment law, estate planning and administration, and transactional law.

To view Michael Klimpl's full bio, click here.

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