Part 2 of our Noncompete Series will focus on employers. Noncompetes, when well drafted, are a powerful tool to protect customer relationships, confidential information, trade and training secrets, and key employee relationships. But, the law does not favor these agreements, so drafting requires care, and, as a practical matter, timing is everything.
While noncompetes are disfavored and maligned, they do serve useful purposes for certain employers. There are two types of restrictions that such agreements can impose: general prohibits on certain kinds of competition; or, prohibitions on soliciting customers, vendors, employees, contractors, or other valuable relationships. For the most part, restrictions on soliciting customers, employees and other key relationships are easier to enforce. They allow the employee to continue to work, and protect those relationships for the employer. For some employers, these restrictions, tailored to their business and in place for a sufficient period of time, are enough. Generally, these restrictions tend to last a year or perhaps two. Employers will need to weigh the dangers of making the restriction too long, and thus unenforceable, as against the time it takes for those relationships to go stale.
Restrictions on competition generally are another matter. The general principle applied by the court is this: a court will not enforce the restriction if it is not designed to protect a legally recognized protectable interest, renders an employee unable to pursue his chosen profession, or appears designed to eliminate fair competition. The court will only act to protect the following interests: trade secrets or confidential information, specialized training the employee received from the employer, or customer good will developed using the employer’s resources. Given these competing factors, it is best to narrowly tailor the restriction to the employer’s business. An employee is more likely to comply with such a restriction (thus avoiding court), and a court is more likely to enforce it as written.
Employers next must consider when to ask employees to sign noncompetes. These agreements are enforceable when signed at the beginning of the employment relationship. A noncompete executed by an employee after the employee has worked for the employer for a period of time is not enforceable unless accompanied by a raise or promotion, or some other benefit. This creates a practice problem for employers. Often, a noncompete is not required at the beginning of employment, but circumstances change: employees are promoted, the nature of the business changes, the employer becomes more sophisticated about its internal procedures, for example. A skilled employee with options in the marketplace may very well refuse to sign such a restriction where the new consideration offered is simply not worth it. So, for example, while a bonus of $500 is enough to make the agreement legally enforceable, it may also not be enough to cause the employee to sign. This creates a difficult situation for the employer – should the employer terminate and lose the key employee, or allow the employee to stay without a noncompete?
Creating a noncompete program for employees is complex, and many of the issue are interrelated. In addition to the legal concerns, employers must consider what concerns and relationships truly require protection, as well as retention and morale issues. We have helped many employers sort through these issues and are uniquely equipped to help businesses navigate difficult noncompete issues.
A recent Washington Post article proclaimed that “even janitors have noncompetes now.” New Jersey and Pennsylvania are considering legislation to regulate the terms and enforceability of documents that restrict employees’ ability to compete with their former employees. "Noncompete Litigation Lessons from the 10th Circuit". These restrictions require discussion and attention: they impact the economy, employee mobility, and the trade secrets and good will of businesses. In the coming weeks, we will explore issues relating to noncompetes in order to shed some light on this complex employment law topic, and offer guidance to both employers and employees grappling with the potential risks and consequences of missteps in these agreements.
This week, let’s start with the basics.
Pennsylvania law recognizes that an agreement that restricts the ability to compete is a restraint on trade, and courts should construe them narrowly. Such agreements are only permitted in two contexts: where they are ancillary to the employer – employee relationship (including independent contractor relationships), or where they are ancillary to the sale of a business. The restriction must be reasonable in terms of scope, geography and time. A court will review whether the restriction in the agreement is narrowly tailored to address certain legally protectable interest, such as good will, trade secrets or specialized training.
Such agreements, as with all contracts, must be accompanied by consideration. In the context of employment-related noncompetes, continued employment will not suffice. Instead, the noncompete must be executed at the beginning of the employment relationship, or, if signed during the employment relationship, accompanied by additional consideration such as a promotion, raise or bonus.
Noncompetes come in many forms: restrictions on working for competitors or setting up a competing business; restrictions on soliciting or accepting work from customers, clients, vendors or suppliers; restrictions on working as an employee for a customer, client, vendor or supplier; and restrictions on soliciting employees away from the employer. Limitations on solicitation are generally more enforceable than blanket restrictions on competition. Some noncompetes are accompanied by a period of severance pay, commonly referred to as “garden leave”. Some agreements include provisions for the employer to release an employee from a noncompete under certain conditions.
When an employee breaches a noncompete, the employer has a powerful weapon to enforce the document: the employer can request an emergency order from the court prohibiting the employee, and even the employee’s new employer, from engaging in activity in breach of the agreement. The court proceeding that results in the emergency order, called a preliminary injunction, usually occurs quickly, and such litigation is expensive and stressful. Often, noncompete agreements have provisions that require the employee to pay the employer’s legal fees in the event of a breach. A court is free to “blue pencil” the noncompete. This means that the court can rewrite the restrictions in a manner that is reasonable and consistent with the employer’s legally recognized protectable interests.
In the next installment of my Navigating Noncompetes series, you will see how to apply some of these basics to examine the issues that employers should consider in drafting and enforcing noncompetes.
Reprinted with permission from the August 18th, 2018 issue of The Legal Intelligencer. (c) 2018 ALM Media Properties. Further duplication without permission is prohibited.
A recent case from the United States District Court for the Tenth Circuit, First American Title Insurance Company, et al. v. Northwest Title Insurance Agency, et al., no. 17-4086, illustrates nicely the complicated issues faced in noncompete litigation, and the risks a good agreement can prevent. Although the case arose in the United States District Court for the District of Utah, the issues confronted and legal principles cited arise frequently under Pennsylvania law.
The individual defendants were employed by First American Title Insurance Company, and had signed various restrictive covenants of one year in duration. All individual defendants were subject to a code of ethics and employee handbook that required employees to use office equipment for company business only, and barred outside activity competing with First American. First American Title Company acquired the stock of First American Title Insurance Company pursuant to a Stock Purchase Agreement. Defendant Smith created defendant Northwest Title Insurance Company, and then quit his job with First American. The day after Smith resigned defendants Carrell and Williams resigned and all individual defendants took positions at Northwest Title Insurance Company, along with twenty-five other employees over the next two weeks. Litigation ensued, and defendants suffered a large jury award at trial.
Lesson 1: File petitions for preliminary injunction early, and make sure to have a tolling provision in the agreement.
The First American District Court denied the plaintiff’s motion for a preliminary injunction after a hearing, finding that there was no irreparable harm. Notably, the individual defendants resigned in March of 2015, and their restrictive covenants, which did not contain tolling provisions, terminated in March of 2016. Plaintiffs filed the petition for preliminary injunction in January of 2016, with only two months remaining on the restrictive covenants, and the motion was not heard until September 2016. The case then proceeded to a trial, resulting in the appeal addressed by the Tenth Circuit. An injunctive order entered early in a case tends to change the dynamic of a case going forward, providing opportunities for sanctions and contempt motions, and an incentive to settlement. Certainly, defendants enjoyed an early victory that rendered this case solely about damages. Indeed, this may well have been the strategy: part of the court’s reasoning on the preliminary injunction was that most of the damage had already been done, in light of the quick transfer of customers and employees.
A preliminary injunction is only powerful when filed early, and it might be worth considering foregoing the motion in certain circumstances, where the tactical advantages of early filing are lost. Most importantly, a tolling provision in the document might have changed the outcome: drafters must include a provision that extends the duration of the restrictive covenant where the employee is in breach.
Reprinted with permission from the February 26th, 2018 issue of The Legal Intelligencer. (c) 2018 ALM Media Properties. Further duplication without permission is prohibited.
At the end of 2017, legislators in Pennsylvania proposed legislation to ban noncompete agreements. The proposal is consistent with a legislative trend in other states. In New Jersey, the Senate proposed a bill (Senate Bill 3518) that would place limits on the ability to impose noncompetes (there is a similar Assembly Bill, A5261). Both of these bills reflect already existing challenges in drafting and enforcing restrictive covenants.
Pennsylvania’s House Bill 1938 was referred to the Labor and Industry Committee on November 27, 2017. The Bill recites a declaration of policy that reads like a defendant’s brief in a preliminary injunction case. It states, summarizing, that the Commonwealth has an interest in the following: allowing businesses to hire the employees of their choosing; lowering the unemployment rate; allowing employees to make a living wage; allowing employees to “maximize their talents” to provide for their families; promoting increased wages and benefits; promoting innovation and entrepreneurship; promoting unrestricted trade and mobility of employees; allowing highly skilled employees to increase their income; attracting high-tech companies; disfavoring staying in jobs that are not suited to qualifications; and disfavoring the practice of leaving the Commonwealth to seek better opportunities.
The Bill defines a “covenant not to compete” broadly as an agreement between an employer and employee that is designed to impede the ability of the employee to seek employment with another employer. Interestingly, the Bill does not seem to distinguish between a non-solicitation restriction and non-competition restriction. The Bill prohibits all “covenants not to compete,” and does not allow a court to rewrite the covenant not to compete to make it enforceable.
There are exceptions: “reasonable” covenants not to compete that relate to an owner of a business; covenants not to compete involving a dissolution or disassociation of a partnership or a limited liability company; and “reasonable” covenants not to compete that were in place prior to the effective date of the statute. One presumes that previous case law regarding what constitutes a “reasonable” restriction on competition will apply. The Bill would allow an employee to recover attorneys’ fees and damages upon prevailing in a suit brought by the employer related to the enforcement of a covenant not to compete.
The historical reluctance of courts to enforce restrictive covenants as written has certainly impacted how and when employers use such documents. Employers (with their attorneys) have attempted to draft documents that a court will enforce, and given careful thought to filing suit in the event of a breach. This Bill, however, would change that calculus dramatically; not just because of the outright ban on arguably both noncompete and nonsolicitation agreements, but also because of the attorneys’ fees provision. Employers who get it wrong will pay attorneys’ fees and damages, including punitive damages, to the employee. It may no longer be wise to file preliminary injunctions as a deterrent or a means to a resolution. If passed, this Bill would require employers to focus on two important concepts going forward, one legal, and one not legal: retention of key employees and protection of trade secrets.
The Bill remains with the House Labor and Industry Committee and does not, at this time, appear on that committee’s schedule.
The New Jersey Bill would also impact the legal and economic strategy of using and enforcing restrictive covenants. Introduced on November 7, 2017, the Bill recites public policy goals with regard to covenants not to compete similar to those recited in the Pennsylvania Bill. The Bill defines a restrictive covenant more narrowly than the Pennsylvania Bill: agreements under which the employee agrees not to engage in certain specified activities competitive with the employer after the employment relationship has ended. The New Jersey Bill does not ban covenants not to compete, but instead imposes a series of restrictions that would seriously impact how noncompetes were enforced and drafted, and would have required employers to pay employees for the period of the restriction. The New Jersey Bill died in committee.
Both Bills reflect the historical judicial reluctance to enforce noncompetes, and change the economics and legal issues related to those agreements dramatically. They are in line with restrictions in other states like California, North Dakota and Oklahoma. Most importantly for practitioners, they reflect that reliance on a well-drafted choice of law provision may not save the day. Case and statutory laws on this particular topic are not really predictable in the usual way. Just by way of example, Massachusetts has eight outstanding bills related to the topic, all of which were the subject of hearing on October 31, 2017, and both Vermont and New Hampshire proposed outright bans earlier this year. Even the results of upcoming elections could change the statutes in any particular state.
These bills proposed late in 2017 reflect current challenges in drafting and enforcing agreements that are enforceable and highlight the importance of considering each decision carefully. Drafters must consider carefully the specific interest an employer is attempting to protect, but even the most careful drafting may not survive new legislation. It will be interesting to see whether, and in what form, legislatures may codify some of these challenges in the future.
Patricia Collins is a Partner with Antheil Maslow & MacMinn, LLP, based in Doylestown, PA. Her practice focuses primarily on employment, commercial litigation, and health care law. To learn more about the firm or Patricia Collins, visit www.ammlaw.com
By Patricia Collins
Reprinted with permission from the February 28th edition of the The Legal Intelligencer © 2017 ALM Media Properties, LLC. All rights reserved.Further duplication without permission is prohibited
The Pennsylvania Superior Court, in Metalico Pittsburgh v. Newman, et al (No. 354 WDA 2016, April 19, 2017), dealt a blow to employees attempting to avoid the application of a non-solicitation covenant.
In Metalico, two employees, Newman and Medred, executed employment agreements containing a covenant not to solicit customers, suppliers and employees during the “Post-Employment Period.” The Post-Employment Period varied depending upon the manner of the termination of employment, and commenced upon the last day of employment with Metalico. At the end of the three-year period, Metalico terminated the employment agreements, but continued to retain Newman and Medred as “at-will” employees, and recited new compensation and other terms of employment. These terms differed from those contained in the employment agreement. Newman and Medred were terminated one year later. Metalico filed suit against Newman and Medred, alleging that they were violating the non-solicitation covenant in their subsequent employment.
On the eve of a preliminary injunction hearing, Newman and Medred filed a Motion for Partial Summary Judgment, arguing that the employment agreements containing the non-solicitation covenants had terminated, and therefore the non-solicitation provisions no longer applied. They argued that the agreement to continue as “at-will” employees acted as a novation of the employment agreement.
The trial court agreed with Newman and Medred, and granted their motion for partial summary judgment. But the Superior Court did not agree. Instead, the Superior Court found that the covenant remained in place pursuant to a survival provision in the employment agreement. That provision stated that if employment under the agreement “expires,” the agreement continues in effect “as is necessary or appropriate to enforce” the non-solicitation covenant.
The trial court found that upon converting Newman’s and Medred’s status to “at will” employees, the parties had stated new terms for the employment relationship going forward. In so doing, the parties did not recite that the non-solicitation provision would stay in place. The failure to continue the compensation and benefits provided in the employment agreement, in the trial court’s view, invalidated the non-solicitation covenant. The trial court justly noted: “Metalico cannot claim the benefits of its bargain while denying its employees the same.”
The Superior Court disagreed, noting that because the survival language was included in the employment agreement, it constituted the bargained-for benefit for the employees. The Superior Court rejected any argument that there was a failure of consideration, because failure of consideration only applies if the consideration was never received – the employees here did receive three years of the promised compensation and benefits under the agreement. The Superior Court refused to find that the parties to the employment agreement intended to terminate and extinguish the previous agreement, thus extinguishing the non-solicitation covenant as well. In so doing, the Superior Court relied upon Boyce v. Smith-Edwards-Dunlap Co., 580 A.2d 1382 (Pa. Super. 1990). However, the Boyce case dealt with the use of the restrictive covenant as a defense to a claim raised by the employee.
It is well-settled that restrictive covenants in employment agreements are disfavored under Pennsylvania law. Courts, including the Superior Court, have refused to enforce such agreements on technicalities. For example, in Socko v. Mid-Atlantic Systems of CPA, Inc., 99 A.3d 928 (Pa. Super. 2014), the Superior Court refused to enforce a covenant not to compete in an employment agreement entered into after the commencement of employment and not accompanied by any beneficial change in the employee’s status, but which recited that it was signed “under seal” under the Uniform Written Obligations Act. The Court found that a seal does not provide adequate consideration to enforce a restrictive covenant. Instead, the Superior Court noted, there must be “actual valuable consideration.” The holding in Socko left employment law practitioners and litigators with the belief that there are no “gotchas” when it comes to restrictive covenants.
Metalico appears to change that. Metalico voluntarily agreed to let the employment agreement terminate and to continue employment on an “at-will” basis. This change of status benefits Metalico, leaving it free to terminate the employees or change their compensation and benefits at will (thus the name) and without concern about the terms of a written agreement. The employees lost these protections. The practical result of the Superior Court’s holding is that the employees lost the protections of the agreement, but retained their post-employment obligations. This is inconsistent with Pennsylvania’s historical animosity towards these restrictive covenants, and appears to truly represent a “gotcha” for these employees.
Metalico expands the universe of enforceable restrictive covenants. This is not an uncommon fact pattern, and one which might have given an employer’s attorney pause prior to filing for a preliminary injunction in the past. The holding could have the impact of reducing the care required in drafting, terminating and enforcing disfavored restrictive covenants, and eliminating some of the defenses available to employees seeking to avoid the covenant. Interestingly, nowhere in the opinion does the Superior Court recite the oft-cited language that such covenants are disfavored in the law. It will be interesting to see if the Supreme Court takes the opportunity to do so on appeal.
Patricia Collins is a Partner with Antheil Maslow & MacMinn, LLP, based in Doylestown, PA. Her practice focuses primarily on commercial litigation, employment and health care law. To learn more about the firm or Patricia Collins, visit www.ammlaw.com.
Restrictions against competition are frequently included in employment agreements and agreements for the sale of business assets or stock. The restriction against competition is designed to secure a time period for the employer or buyer of business assets, as the case may be, during which the employer/buyer is free from competition for a departed employee or seller so as to facilitate the transition and better protect their own business assets and customer relationships. If properly drafted and implemented, restrictions against competition are enforceable under Pennsylvania law.
The primary method of enforcement in the event of breach is a preliminary injunction in equity. In order to prevail on a petition for preliminary injunction, a petitioner must demonstrate several factors including (1) the need to prevent irreparable harm which cannot be compensated by money damages, (2) that more harm will result from the denial of the preliminary injunction than from granting same, (3) that the injunction will restore the parties to the status quo, (4) the likelihood of success on the merits, (5) that the injunction is designed to abate the offending activity, and (6) that the injunction will not negatively impact public policy. In most cases the issues of likelihood of success on the merits and irreparable harm incapable of compensation with money damages represent the contested issues.
In Bucks County, the petition for preliminary injunction must be accompanied by a verified complaint and an order for hearing. The petition is often, though not always, heard by the initial pre-trial judge assigned to the case at the time of filing. Court administration reviews all petitions for preliminary injunction and assigns the presiding judge, courtroom and date for evidence to be taken. The order for hearing is an essential aspect of the petition; without it, no hearing will be scheduled.
The petitioner in any injunction matter bears a heavy burden. Adequate evidence as to the need for enforcement of the covenant, the potential irreparable harm and right to relief must be presented. Because the entry of injunctive relief is an extraordinary remedy, the evidence must be clear and persuasive. In employment and business asset transfer cases, the language of the restriction in the applicable agreements must be constrained to those aspects of competition which are reasonably necessary for the protection of the employer/buyer. For example, a covenant which is overbroad in terms of geography, time or scope will not be enforced.
Preliminary injunctive relief may be acquired in the Bucks County Court of Common Pleas if supported by the underlying agreement and if properly perfected under the practices and procedures employed in the County.
Employment agreements, especially those for key employees which include non-competition terms, must be carefully drafted. What should they include? Here are eight (what’s magic about ten?) musts:
1. Define the Restrictions. The non-compete should, first and foremost, clearly define the prohibited zone by industry segment, by geography and by time. Because these covenants are disfavored in the law (certainly by every trial court which I’ve ever asked to enforce one of these agreements) employers must leave no doubt about the restrictions and be able to tie each to an identifiable protectable interest. The covenants are not enforceable unless they are required to protect such interests, and then only to the extent the restrictions are reasonable.
2. Protectable interest? Courts will not enforce these covenants unless the employer has an interest which can only be protected by the restriction. Eliminating competition is not a protectable interest but, for example, protecting customer relationships is. Consider how the particular employee could hurt your business and tailor the restrictions to provide protection in those areas.
3. Reasonable? A covenant prohibiting competition anywhere in the country is not likely to be enforced where the employee’s relationships were confined to one state or region of the country. Such a broad restriction would likely be found to be unreasonable. Similarly, temporal restriction should be limited to the time required to give the employer’s new representative time to meet and solidify relationships with the customers.
4. Don’t forget to protect your people. A well drafted employment agreement will include provisions which prohibit the employee from inducing your employees to move to the new employer. Losing one key employee is bad enough; losing three or four may be catastrophic.
5. What happens if the employer sells the business? Unless the covenant can be assigned, it is lost and the employee is free to compete. Restrictive covenants are important assets of the business. Absent assignability, the value of those assets is lost if the business is sold.
6. A tolling provision? It may take some time for an employer to learn that a former employee has violated the covenant. Litigation to stop that violation takes more time. A well drafted document will include a tolling provision which stops the clock from running while the employee is in breach.
7. Protect confidential information. The employment agreement should protect confidential information and trade secrets. Employees are often privy to sensitive information which is necessary to do their job. When they leave employment, that information should stay behind. Make sure that the employment agreement provides that confidential information and trade secrets will not be “used or disclosed” after the sale. Define confidential information as broadly as possible, but keep in mind that it does not include information known to the public or easily discoverable.
8. Make violation risky. The former employee must know that if he chooses to violate, it will cost him. The tolling language, mentioned above is one way to get that point across. Another is to provide for recovery of attorney’s fees if the restrictive covenants are violated and enforcement litigation results.
There is a large body of state specific law surrounding the interpretation and enforcement of these agreements. Make sure the attorney who you engage is experienced in this area of the law.
In a recent case that may not bode well for the enforcement of noncompete agreements in Pennsylvania and New Jersey, the Virginia Supreme Court reversed twenty years of Virginia precedent relating to noncompetes, agreements pursuant to which an employee agrees not to compete with an employer for a period of time after the termination of employment. Until this recently, Pennsylvania, New Jersey and Virginia had similar laws relating to noncompetes. Historically, courts in all states have not looked favorably on such agreements, and have used various tools to limit or deny enforcement of noncompetes. Prior to the court’s decision in Home Paramount Pest Control v. Shaffer, the law in Virginia was similar to Pennsylvania law: a Court could re-write overbroad noncompete agreements so that the document was consistent with the employer’s protectable interests. In Home Paramount Pest Control, the court stated that it would no longer re-write such provisions, and that it was free to refuse to enforce a noncompete that was overly restrictive.
The former employee in Home Paramount Pest Control signed a noncompete agreement that prohibited him from competing with his former employer’s fumigation business in any manner, in any geographic area where he worked for Home Paramount Pest Control for a period of two years after his termination. Prior to this case, it was well settled that if the court found the restrictions of the noncompete broad, it could rewrite the document and enforce more reasonable provisions. The court generally exercised its re-writing power to limit the geographic or temporal scope of the document, or to find that specific conduct did not violate a noncompete if the employer could not articulate a protectable interest in prohibiting the conduct, even where the clear language of the agreement prohibited the competitive conduct. Generally speaking, “protectable interest” means that the employer has provided something to the employee that it has the right to protect, such as access to trade secrets, or specialized training. If the restriction on future employment did not match a protectable interest, the court would not enforce the restriction.
In Virginia at least, this is no longer the case. The Virginia Supreme Court noted that it had “incrementally clarified” the law relating to noncompetes so dramatically over the past two decades that it was free to find the noncompete unenforceable in this case. Most interestingly, the court focused on language that lawyers generally believe is good drafting. The agreement in question contained a list of prohibited activities designed to address every conceivable kind of competition, as well as the ubiquitous “in any capacity whatsoever” catch-all for good measure. The court found that the employer could not articulate a protectable interest that would justify such a sweeping prohibition. Specifically, the court was looking for a nexus between the employee’s job duties, and the prohibitions imposed by the noncompete.
In the good old days, the court would simply have revised the agreement to remove whatever restrictions were too broad, such as the “in any capacity whatsoever” language. Or, the court may have found that there was no protectable interest in prohibiting the employee from engaging in his current employment. But the Virginia Supreme Court refused to do so, noting that incremental changes in the law required a different result. I will not bore the reader with the court’s very interesting discussion of how the doctrine of stare decisis applies to the case, except to note that the court recognized its decision as a departure from well-settled law.
While this case does not apply in Pennsylvania or New Jersey, many states have seriously limited the enforceability of noncompetes. We are making sure to discuss these issues with our clients, and draft noncompetes as narrowly as possible. We are also thinking creatively about other solutions to the problem of competition, trade secrets and specialized training, such as non-solicitation provisions. The Virginia Supreme Court has given us new reasons to draft carefully.
A company’s customer lists, price lists, marketing strategies, and other trade secrets are vital to its success. A smart business owner will ensure that key employees sign non-disclosure and non-compete agreements to protect the business if the employee leaves and takes a job with a competitor. But what if the company is sold? Does the buyer enjoy the benefits of the restrictive covenants contained in the selling company’s employment agreements? The answer is “it depends.” In Pennsylvania, if the purchase is structured as an asset purchase transaction, the buyer does not receive the benefit of the restrictive covenants contained in the seller’s agreements with its employees unless those agreements specifically state that the covenants are assignable. This is because these covenants are viewed as trade restraints that impair a former employee’s ability to earn a living and therefore are interpreted as narrowly as possible to protect the employer’s legitimate business interest.