Reasonable is Key
It is a staple of contract law that the non-breaching party should be compensated for the “benefit of the bargain.” However, when the bargain is struck between an employer and an employee in a non-competition covenant, ordinary contract law principles may be outweighed by policy considerations.
As in many states, non-competition covenants in Pennsylvania are seen as a restraint on trade and are not favored by the courts, particularly if drafted by the employer and not negotiated between the parties. Enforcement of non-competition clauses results in a balancing of the employer’s legitimate protectable interest(s) against the hardship imposed upon the employee by the restriction upon the employee’s ability to work.
Many employers understandably want to limit or eliminate the ability of all or certain key employees to compete with the employer, whether that employment is severed as the result of an amicable separation or a termination.1 Certain essential concepts must be kept in mind at the beginning (when entering into non-competition agreements) and at the end of an employment relationship (when deciding whether and how to attempt to enforce such agreements).
One indispensable component of an enforceable non-competition clause is that there must be adequate consideration for the employee to enter into the agreement.2 For a new employee, that consideration can be the job itself. Pennsylvania courts have uniformly determined that adequate consideration exists for restrictive employment covenants that are part of the formation of the employment relationship. For a non-competition agreement that is signed in connection with the acceptance of an offer, at the very beginning of an employment relationship, or shortly thereafter (i.e., within a few days or possibly a week or two), the position itself will likely be sufficient consideration.
For new employees, the best practice is to include in the offer letter a statement indicating that a condition of employment is entering into a non-competition agreement, or an employment agreement that contains a non-competition clause. Including a specific reference to the non-compete in the offer letter puts the employee on notice and demonstrates that it was a bargained-for part of the employment negotiation process.
For current employees, however, continued employment or a token consideration will not be sufficient to support the imposition of a non-competition covenant. There is no tried-and-true formula for what is adequate consideration to support the imposition of a non-competition covenant during the course of an employment relationship.
Factors that will be taken into account to evaluate the adequacy of consideration for a restrictive covenant entered into during employment include the type of job at issue, the level of the employee’s responsibility, the employee’s salary history and previous benefits, and the breadth of the restrictions in the non-compete. The compensation exchanged for the non-competition must be material when considered in light of those factors. So a bonus or pay raise must not be merely a token amount in relation to the employee’s prior salary if intended to support a non-compete. Likewise, the promise of benefits that are also offered to all other employees will not be adequate consideration for a current employee to enter into a non-competition agreement.
In contrast, offering a combination of incentives — such as a bonus, pay raise, and/or new or different benefits, which may include a severance package — for a current employee to accept a non-competition restriction increases the likelihood of enforceability. Moreover, a change in status or responsibility may be sufficient consideration alone for a restrictive employment covenant. For example, if the non-competition agreement is entered into at the end of the employee’s probationary period, the offer of permanent employment may be sufficient. Likewise, a promotion or a change in employment status to an independent contractor could be seen as adequate consideration.
In addition, it is important for employers to tailor non-competition covenants or agreements to specific employees, not job titles, and also to consider having employees enter into new non-competition agreements at each promotion, change in status, or increase in responsibility. Even if a form agreement is used, tailoring the non-competition restrictions with the employee’s particular employment duties, training, or level of responsibility in mind makes it more likely that a court will later strike the balance in favor of the employer’s legitimate interest in limiting unfair competition by the employee. Moreover, re-executing non-competition agreements at different stages of an employee’s career with the employer makes it possible that if an earlier non-compete is unenforceable due to a lack or inadequate consideration, that same impediment may not prevent the enforcement of a subsequent agreement.
Employer’s Legitimate Protectable Interest(s)
The validity of a non-competition agreement rests upon a threshold determination that it is necessary to protect the employer’s legitimate interest(s). If the restrictive covenant, however, is seen as designed to simply restrain all competition or to gain an unfair economic advantage over the former employee, the non-competition covenant will not be upheld. Legitimate protectable interests for an employer include such things as goodwill and customer relationships, a specialized employment training program, or an employee’s unique skill or knowledge.
The courts have recognized that an employer has a legitimate right to protect the goodwill and relationships fostered with customers, even where developed or maintained through the efforts of the departing employee. The most effective non-competition clause in this regard will be tailored to the employer’s current customers, or specific customer prospects, rather than an overly broad covenant attempting to encompass the public at large.
Pennsylvania cases have also recognized an employer’s investment in specialized training methods or procedures as an interest that may be protected by a non-competition agreement. Nonetheless, a determination will be necessary to establish that the employer’s particular methods are in fact specialized and distinct, not generalized or ordinary business techniques.
Moreover, it is legitimate for an employer to seek to prevent competition from a departing employee with unique skills, or special knowledge or ability. In this regard, tailoring the form of non-competition agreement for key or high-level employees is more likely to demonstrate the employee’s distinctive skill set or the employer’s unique or intensive training methodology as a legitimate protectable interest, rather than a one-size-fits-all boilerplate restriction.
Reasonable Restrictions of Time and Scope
It is axiomatic that non-competition covenants must be reasonable in duration and in geographic scope. The employee has the burden of proving that a non-competition restriction is unreasonable, and the reasonableness determination is very fact-specific.
The validity of the restrictions will be governed by the type of interest protected, and factors exclusive to an industry or even a particular business likely may drive the determination. For example, in traditional industries where development of client relationships may take years, a non-competition covenant of a year or more may considered reasonable. But in industries where the technology or information rapidly changes or becomes public, that same time-frame may be unreasonable. Likewise, the geographic scope of the restriction must be reasonably related to the employer’s interest and the harm that the employer may suffer from a breach. So a reasonable limitation on a salesperson may be a particular territory, or even specific customers, rather than a nationwide ban.
The usual remedy for breach of a non-competition clause is an injunction, but damages may be awarded in certain instances. Pennsylvania is a “blue pencil” state so a restrictive covenant that is overly broad may still be enforced for a lesser duration or a smaller geographic area, but it is crucial to be able to articulate and demonstrate the employer’s legitimate interests.
Another factor that may be considered in an enforcement proceeding is whether or not the employee was terminated, and for what reason. Some courts have viewed a performance-based termination as an indication that the employer would not be harmed by competition from that former employee. However, severance due to wrongful conduct should not prohibit enforcement of a restrictive covenant.
Enforcement of a non-competition agreement through an injunction, particularly a special injunction, will be time-consuming and expensive. The employer should have realistic objectives and not seek to enforce overly broad or clearly unreasonable restrictions.
Often the most cost-effective approach is to ensure that an appropriately tailored agreement is in place at the beginning and is renewed at strategic points during the course of employment. The assistance of your legal advisor in drafting, evaluating and enforcing restrictive covenants can be invaluable.
1 Employers may also be concerned about preventing competition by an employee during the employment relationship. Although the scope of a restrictive covenant may include this type of competition, Pennsylvania common law already imposes a fiduciary duty on an employee not to compete with an employer during the course of the employment. However, even during the employment period, employees may “prepare” to compete (e.g., setting up a new entity, obtaining financing, entering into contracts), even to the extent of scheduling appointments, but may not actually solicit customers, misappropriate trade secrets or confidential information, engage in fraud, or otherwise directly damage the employer.
2 Some Pennsylvania courts have discussed another requirement – that the non-competition covenant be “ancillary to the employment relationship” – but other courts have indicated that this additional requirement is the same as whether there is adequate consideration. For those cases discussing “ancillary to employment” as an additional condition to enforceability, a restrictive covenant will be considered void as against public policy unless it is made in connection with the sale of a business or an employment contract.
For additional information on perfection of security interests and the usage of other credit enhancements, please see the other articles in this Publications section.