Non-Compete Covenants – An Overview
Non-compete covenants are a routine part of the business landscape. Many employment contracts and business agreements contain detailed and often lengthy provisions written to ensure that business sellers and employees will not be able to compete with their former businesses after they leave. Indeed, an employer’s desire to obtain protection against competition is often the primary reason why an employment contract is reduced to writing in the first place.
In legal parlance, the standard justification for non-compete covenants is the need to preserve the customer goodwill and proprietary information of a business following the departure of one who is closely associated with the business’ goodwill or in possession of its proprietary information. In business language, the goal is to prevent a key employee or prior owner of a business from setting up shop across the street with the clients and trade secrets of the business he just left.
A non-compete covenant is often a business necessity. It is also, by its very nature, a restraint of trade. In many cases, a non-compete covenant imposes an overwhelming hardship upon a former employee’s ability to earn a livelihood. This is particularly true where the covenant has the effect of prohibiting an employee from working within the only trade she has ever known. It is for these reasons that the Pennsylvania courts have decreed various limits on the enforceability of non-compete covenants. As with many questions of law, these limits are not spelled out in precise, bright-line rules, and are not codified in a book or statute. Instead, the courts have ruled on particular non-compete covenants on a case-by-case basis in a series of decisions handed down over the years. It is only by reviewing the body of this case law and the reasoning behind each decision that we can draw some rough guidelines about which non-compete covenants will probably be held enforceable, and which will not.
Some non-compete covenants have been held to be too long in duration or too extensive in geographic area to be enforced as written. Other covenants have been ruled unenforceable for a more fundamental reason – the absence of sufficient legal “consideration.”
At the risk of over-simplifying a concept that occupies weeks of the typical 1L course in contract law, consideration means a bargained-for exchange, where each party to the contract agrees to give up some right or benefit as part of a transaction. Consideration is generally not an issue when a non-compete covenant is signed in connection with the sale of a business or at the time an employee is first hired. In each of these cases the non-compete covenant will usually be deemed a part of what the business purchaser or employer was bargaining for at the outset.
The consideration problem typically arises where the employer approaches an existing employee and demands that the employee sign a non-compete covenant under an explicit threat, or more often than not, an implied threat, that the employee will be fired if he does not sign. In most states, the courts have resolved this question by reasoning that if the employment was at-will anyway, as it usually is, the employer’s continuation of the employment relationship following the signing of the covenant is by itself sufficient consideration for the non-compete covenant.
Although the Pennsylvania courts at times have come close to embracing this majority rule, Pennsylvania remains one of the few states that still requires some “new” consideration in order for an employer to bind an existing employee to a non-compete covenant. With that said, however, the new consideration requirement is generally not difficult for an employer to satisfy. On the one hand, it is not enough for an employer to provide mere token consideration such as the standard annual raise or a $200.00 bonus or a promise to provide the employee with two weeks notice prior to termination. And while a $1,000.00 signing bonus is likewise probably not enough new consideration, any bonus greater than $1,000.00 probably would be held sufficient. A genuine promotion over and above the standard annual raise is likely to be deemed a sufficient new consideration. Moving an employee from part-time to full-time is also likely to be deemed sufficient new consideration, particularly if the employer accompanies the expansion of the employee’s hours with the addition of fringe benefits such as health insurance coverage. Likewise, changing an employment from at-will to a written year-to-year term, or changing a worker’s status from independent contractor to employee, with the accompanying employer contributions toward payroll taxes and unemployment compensation, will also be sufficient new consideration in most cases.
A 1992 Pennsylvania Superior Court decision provides some support for the proposition that a package of additional new benefits, taken together, might be sufficient new consideration, even though none of the benefits within the package would be sufficient new consideration in and of itself. In Davis & Warde, Inc. v. Tripodi , 420 Pa.Super 450, 616 A.2d 1384 (1992), a divided panel of the Superior Court held, 2-to-1, that a one-time payment of $100.00, a new company policy regarding reimbursement for automobile expenses, and a promise of two weeks notice and two weeks severance pay in the event of termination were, in combination, sufficient new consideration to bind an existing employee to a non-compete covenant. Given that it is now many years since the Davis & Warde decision was handed down, and given further that $100.00 today is not worth what it was even in 1992, an employer seeking to bind an existing employee to a non-compete covenant would be well-advised to offer the employee significantly more than the bare-bones package at issue in Davis & Warde .
Duration and Geography
In order to be enforceable, a non-compete covenant must be limited in time and place, or limited in terms of the specific customers that a parting employee or seller is prohibited from soliciting or servicing. In nearly every case, the question is either how long is too long or how far is too far. The answer is always dependent upon the particular circumstances of the business and upon the importance of the departing individual to the operation and goodwill of that business. The proper inquiry focuses upon the determination of how long and how far the non-compete must extend in order for the business to strengthen and reaffirm its customer relations following the departure of the former employee or owner. If there is no legitimate business interest to be served by preventing a departing employee from doing the same sort of work for a competitor, as is generally the case with an assembly line worker, a clerical worker, or a warehouse worker, the covenant will not be enforced at all. Otherwise the courts will balance the interests of employer and employee in assessing the reasonableness of the duration and geographic scope of a covenant.
Restrictive covenants arising out of employment are subject to a more stringent test of reasonableness than non-compete covenants entered into in connection with the sale of a business. The heightened scrutiny of employment-related covenants stems in part from the historical reluctance of the courts to restrain an individual from earning a living at her trade, and also in part from the courts’ recognition of the inherently unequal bargaining positions of employer and employee when entering into these agreements. Thus, the courts generally start their analyses of these cases with the proposition that a departing employee’s ability to earn a livelihood should not be restricted any longer or any farther than is reasonably necessary to protect the employer’s legitimate business interests.
Assuming that the covenant is otherwise valid, a duration of one year or less will almost always be enforceable, and a duration of more than five years will rarely be enforced, if ever. The typical covenant, restricting competition for a period of two to three years following separation from employment is rarely subject to successful attack on grounds that it is too long in duration. Generally speaking, if an employer seeks to enforce an employment-related covenant for a period longer than two to three years, the employer should be prepared to show that the employee worked for the company for a significant period of time and had substantial customer contact or had access to significant proprietary company information, or both.
Determining the reasonable geographic scope of a non-compete covenant requires an analysis of the particular business market, the territory in which the employee provided services, and the extent of the proprietary knowledge held by the employee. The geographical limits of non-compete covenants are often written to be co-extensive with employer’s business service area or the particular territory which the employee served. For companies with large national or regional service areas, non-compete covenants may include entire multi-state regions. For smaller or locally based companies – where the target market is defined by proximity to the companies’ principal places of business – the geographic limits are often defined as an area within a certain radius (e.g. twenty-five miles or fifty miles) from the business location. Other non-compete covenants avoid the use of geographical limits altogether, and instead limit the employee from soliciting or doing business with certain named customers of the company or, in some cases any customer whom the company served during the employee’s tenure.
There are few reported appellate decisions in which the Pennsylvania courts have refused to enforce the geographic limits of a non-compete covenant. Generally speaking, so long as the geographic scope is drawn to protect the employer’s legitimate interests rather than to gratuitously punish an employee for leaving the company, the court will uphold geographical restrictions based upon the employer’s service area or the employee’s service territory.
An employee seeking to strike out on his own and test the limits of his covenant not to compete would be well-advised to consult with the lawyers of Wolf, Baldwin & Associates, P.C. . Even if the covenant exceeds permissible limits of duration or geography, the employee should not simply assume that the covenant will not be enforced. A court may nevertheless choose to enforce the covenant for a reduced period of time or over a truncated geographical area, effectively rewriting the covenant to render it enforceable. Further, an employee will often assume that if her employment ends by firing or layoff, rather than by resignation, she will not be bound by the non-compete covenant. However, while the courts are often reluctant to enforce the full measure of a non-compete covenant if the court believes that the employee has been treated unfairly, this is not always the case, and the employee should usually proceed on the assumption that the non-compete covenant will be binding.
If a court finds an employee to be in violation of a non-compete covenant, the court can award the former employer an injunction, restraining the employee from further competition upon threat of contempt sanctions, or could award the former employer monetary damages, or both. Further, it is sometimes the case that the damages the former employer sustains from such competition exceed the net economic benefit the employee derived from the competition. It is therefore possible that an employee could be forced to pay damages in excess of the income he has actually earned from the competition. For this reason, it is important for any employee who has signed a non-compete covenant to proceed very carefully before taking a new position in the same industry. It is also worth considering that even in a case where an employee is barred from competition by reason of a non-compete covenant, it is sometimes possible for the employee or his legal counsel to negotiate a buy-out of the covenant. In any event, if an employee wishes to move to a new position within the same basic industry after having signed a non-compete covenant, he should do so only after consulting with legal counsel.
The attorneys of Wolf, Baldwin & Associates, P.C. have experience representing both employers and employees in many types of employment claims. We can help employees who are negotiating or subject to non-compete agreements, and we can counsel businesses regarding actual and potential employment claims. Our lawyers can help you learn your employment law rights and protect those rights. Click here to contact us now to schedule an appointment.
- Employee or Independent Contractor?
- The Statute of Frauds for Real Estate and the Sale of Goods in Pennsylvania
- When Can an Employee Collect Unemployment Compensation?
- Employee Handbooks – Contracts or Guidelines?
- Protecting Your Business Against Discrimination Claims
- An Employee’s Duty of Loyalty to An Employer
- Terminating the At Will Employee
- Labor Law Postings
- Secret Profits – A Violation of Duty
- Wage Payment and Collection
- Pitfalls of Buying or Selling a Business
- Family and Medical Leave Act