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Consideration Required to Bind Existing Employees to Non-Competes, Pennsylvania Supreme Court Holds

By Douglas G. Smith
  • November 25, 2015

An employee is not bound by a non-compete agreement signed during the course of his employment if he was not offered additional consideration, even though the agreement expressly stated the parties “intend to be legally bound,” the Pennsylvania Supreme Court has held in a 4-1 decision. Socko v. Mid-Atlantic Systems of CPA, Inc., No. 142 MAP 2014 (Nov. 18, 2015).

Background

When the employee was hired for a sales position at a waterproofing company in March 2007, he executed a two-year employment contract containing a non-compete agreement. The employee resigned almost two years later, but he was rehired four months after he resigned. At the time he was rehired, the employee signed a new employment agreement, which also included a two-year covenant not to compete.

On December 28, 2010, while still employed by the company, the employee signed a third, more restrictive, non-compete agreement, which, by its terms, superseded all prior agreements. The employee did not receive any additional compensation, or any other benefit or other change in his existing employment status, when he signed the new agreement.

On January 16, 2012, the employee again resigned from the company. A few weeks later, he accepted a position with a competitor located within the geographic region covered by the restrictive covenant in his December 2010 agreement. When the company provided a copy of the employee’s non-compete agreement to his new employer, and threatened the competitor with a lawsuit, the new employer terminated the employee.

The employee subsequently filed suit against his original employer, seeking a determination that the December 2010 non-compete was unenforceable because it was not supported with adequate consideration. The trial court and the Pennsylvania Superior Court agreed with him, finding that continued employment, by itself, is not sufficient consideration to support a non-compete agreement. The company then appealed to the Pennsylvania Supreme Court.

Supreme Court Decision

The company argued that the December 2010 non-compete agreement was enforceable, despite the lack of additional consideration, because the agreement was saved by the “magic language” of the Uniform Written Obligations Act (“UWOA”).

The UWOA, a model law drafted early in the 20th century that was adopted by only two states and only remains in effect in Pennsylvania, states that a written promise “shall not be invalid or unenforceable for lack of consideration” if it contains “an additional express statement that the signer intends to be legally bound.” 33 P.S. § 6.

The company argued that, because the December 2010 non-compete agreement expressly stated that the parties intended to be legally bound, the employee could not assert lack of consideration to avoid the restrictive covenants.

The Supreme Court disagreed. Although, at first, the Court considered that the plain language of the UWOA appeared to support the company’s position that the non-compete agreement was enforceable because it contained the UWOA’s “saving language,” the Court did not end its inquiry there. Instead, relying on one of Pennsylvania’s cannons of statutory construction, the Court concluded that construing the UWOA to mean that no consideration is needed for a non-compete agreement, provided it contains the requisite language from the statute, would lead to “an absurd or unreasonable result” in light of Pennsylvania’s “long, and virtually uniform, history of strongly disfavoring covenants in restraint of trade.”

The Court also emphasized that “in the post-commencement employment scenario, strict compliance with various requirements, including new and valuable consideration, beyond mere continued employment, [is required] to permit enforcement of the restrictive covenant.”

Ultimately, the Court held:

In sum, while at common law, covenants in restraint of trade have long been disfavored by Pennsylvania courts, an agreement containing a non-compete clause will be upheld, if, among other considerations, it is supported by adequate consideration. In the context of requiring an employee to agree to a restrictive covenant mid-employment, however, such a restraint on trade will be enforceable only if new and valuable consideration, beyond mere continued employment, is provided and is sufficient to support the restrictive clause.

Upholding the lower court decisions, the Court rejected the company’s argument, declaring, “[A]n employment agreement containing a restrictive covenant not to compete may be challenged for lack of consideration even though the agreement, by its express terms, indicates that the parties ‘intend to be legally bound’ pursuant to the UWOA.”

The Court reaffirmed Pennsylvania’s longstanding principle that to enforce a non-compete agreement entered into after an employee commences employment, the employer must provide the employee with “new and valuable consideration – that is some corresponding benefit or a favorable change in employment status,” regardless of any contractual language about an “intent to be bound.”

Implications

For the most part, the Court’s decision does little to change the landscape of Pennsylvania’s law of restrictive covenants. As the Court itself noted, it has long been held that new and valuable consideration is required to enforce a non-compete agreement entered into during the course of an employee’s employment. However, for the first time, the Court stated definitively that employers may not rely on the “intending to be legally bound” language of the UWOA as a substitute for adequate consideration or as means of foreclosing an employee from challenging the agreement based upon the lack or inadequacy of the consideration.

Thus, when asking an existing employee to sign a restrictive covenant, employers should consider carefully whether the agreement is supported by adequate consideration. Employers also should review their existing agreements to confirm the adequacy of the consideration.

When employees sign a non-compete at the time of hire, the commencement of employment provides the requisite consideration to enforce the agreement. However, for agreements signed during an employee’s employment or at its conclusion, employers should consider whether the employee has received a “benefit or a favorable change in employment status,” because mere continued employment, regardless of the terms of the employment agreement, is insufficient to serve as consideration.

Examples of a “benefit or a favorable change in employment status” include:

  • A promotion;
  • A change from part-time to full-time status;
  • A salary increase;
  • A favorable change in other aspects of the compensation package – bonuses, stock options, enhanced benefits, and the like; or
  • A one-time bonus payment or severance payment to which the employee was not previously or otherwise entitled.

The Jackson Lewis Non-Competes and Protection Against Unfair Competition Practice is available to talk to employers about the impact of the Pennsylvania Supreme Court’s ruling in Socko v. Mid-Atlantic Systems of CPA, Inc. on their businesses, as well as help employers prepare and enforce restrictive covenant agreements with their employees.

©2015 Jackson Lewis P.C. This material is provided for informational purposes only. It is not intended to constitute legal advice nor does it create a client-lawyer relationship between Jackson Lewis and any recipient. Recipients should consult with counsel before taking any actions based on the information contained within this material. This material may be considered attorney advertising in some jurisdictions. Prior results do not guarantee a similar outcome.

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