Pennsylvania Non-competition agreements

posted by Christopher Ezold  |  Aug 3, 2009 10:13 AM [EST]  |  applies to Pennsylvania

“Non-competition” or “noncompete” agreements are one of a particular kind of contract, termed “restrictive covenants,” under Pennsylvania law.  As in most states, noncompetition agreements are disfavored in Pennsylvania as a prior restraint on trade; however, such covenants are not per se unreasonable or unenforceable. See Hess v. Gebhard & Co., Inc., 570 Pa. 148, 157-60, 808 A.2d 912, 917-18 (2002); Jacobson & Co. v. Int'l Env't Corp., 427 Pa. 439, 235 A.2d 612 (1967); Insulation Corporation of America v. Brobston, 446 Pa. Super. 520, 667 A.2d 729, 733 (Pa. Super. 1995).

Pennsylvania Law on Restrictive Covenants in Employment

In order to be enforceable, a noncompetition agreement must be:

1. ancillary to the sale of a business or a contract of employment;
2. supported by adequate consideration;
3. reasonably limited in geographic scope and time, and
   
4. designed to protect the legitimate business interests of the employer.
   

Morgan's Home Equipment Corp. v. Martucci, 390 Pa. 618, 629, 136 A.2d 838, 844 (1957); All-Pak v. Johnston, 694 A.2d 347, 350 (Pa. Super. 1997).

Adequate Consideration and Ancillary to a Contract of Employment

 Whether a noncompetition agreement is ‘ancillary to a contract of employment’ is generally not in dispute – either there is an employment relationship or there is not.  However, an increasing issue is whether a contractor is bound by a noncompetition agreement.  The law in this area is not well settled in Pennsylvania.  Court rulings exist which state that a contractor is not an ‘employee’ and therefore any noncompetition agreement with that contractor is not ‘incident to a contract of employment;’ other rulings state that the independent contractor relationship is so similar to that of an employment relationship that a noncompetition agreement may apply.  See Quaker City Engine Rebuilders, Inc. v. Doreen L. Toscano, 369 Pa. Super. 573, 583, 535 A.2nd 1083, 1089 (Pa. Super. 1987). Finally, one court has held that a former employee, who becomes an independent contractor of the same employer, will be bound by a restrictive covenant as the agreement is incident to the prior employment relationship.  Id.

The primary issue tends to be whether there is ‘adequate consideration’ for the promise not to compete.   That is, does the agreement provide the employee with enough value to make the noncompetition agreement enforceable?  Generally, giving a person employment is sufficient; however, ‘continued employment’ is not sufficient. George W. Kistler Inc. v. O'Brien, 464 Pa. 475, 484, 347 A.2d 311, 316 (Pa. 1975).  Some new benefit must be provided, such as a raise outside of the normal course of business, a promotion, a cash payment, etc. (although exactly how much of a raise or cash payment is enough is a matter of dispute; it must be more than ‘nominal.’)

Therefore, if an employee does not sign the noncompetition agreement on the first day of work, it is generally not enforceable without further consideration paid.  The courts have held, however, that the timing of the agreement between the employer and the employee, not the first day of work, controls whether ‘employment’ has been offered as consideration.  For instance, if an employee is solicited by an employer, and they agree on a position and a pay rate, without further discussion, the deal has been struck at that time and addition of a noncompete, even on the first day of work, requires further consideration.  However, if an employee is aware prior to beginning work that a noncompetition agreement must be signed, but delays signing for several days after beginning work, the noncompetition agreement is still enforceable.

Legitimate Business Interest

The controlling law on legitimate business interests in Pennsylvania was reviewed and restated by the Supreme Court of Pennsylvania in Hess v. Gebhard & Co., Inc., supra.   First, to be enforceable, a noncompetition agreement must be ancillary to a contract of employment and reasonably necessary for the protection of a ‘legitimate business interest’ of the employer.  Hess, 570 Pa. 148, 157-60, 808 A.2d 912, 917-18.   The fundamental question underlying the validity of a noncompetition agreement is the initial analysis of whether it “reasonably relate[s] to the protection of a legitimate business interest.”  Hess, 570 Pa. at 160, 808 A.2d at 918, 920.  Pennsylvania “law permits equitable enforcement of employee covenants not to compete only so far as reasonably necessary for the protection of the employer.”  Sidco Paper, 465 Pa. at 594, 351 A.2d at 254 (1976) (emphasis added). Generally, interests that can be protected through restrictive covenants include good will, trade secrets and confidential information, unique or extraordinary skills and investment in an employee training program.  Hess, 570 Pa. at 163, 808 A.2d at 920; Pennsylvania Funds Corp. v. Vogel, 399 Pa. 1, 7-8, 159 A.2d 472, 475-76 (1960); Morgan’s Home Equip. Corp. v. Martucci, 390 Pa. 618, 136 A.2d 838, 846 (Pa. 1957).

 Many business interests are insufficient to meet the threshold test.  A noncompete is not valid if its purpose is merely to protect the employer against competition or “to keep the employee from competing so that the employer can gain an economic advantage.”  Hess, 570 Pa. at 163, 808 A.2d 922.

 If the conditions precedent are met, the court must then balance the employer’s interest in protecting its legitimate business interest against the employee’s interest in further employment.  Id.  This balancing test takes into account the reasonableness of both the duration of the noncompete and the geographic or substantive scope of the noncompete.  Id.; Thermo-Guard, Inc. v. Cochran, 408 Pa. Super. 54, 596 A.2d 188, 193 (Pa. Super. 1991).[1]

 In weighing the competing interests of employer and employee, the court must engage in an analysis of reasonableness.  First, the covenant must be reasonably necessary for the protection of the employer. Hess, supra at 157, 808 A.2d at 917.  In addition, the temporal and geographical restrictions imposed on the ex-employee must be reasonably limited. Id.; Brobston, supra at 733-734.  The determination of reasonableness is a factual one, requiring consideration of all the facts and circumstances, with the party claiming unreasonableness as a defense against enforcement of the covenant bearing the burden of proof.  Wellspan Health v. Bayliss, 2005 Pa Super. 76 (Pa. Super. 2005).  An unreasonable covenant will not be enforced, but the court, in its discretion, may alter or “blueline” the terms of the agreement to conform with equity. Jacobson, at 451, 235 A.2d at 619;  Hillard v. Medtronic, Inc., 910 F. Supp. 173, 176-77 (M. D. Pa. 1995)

Finally, because noncompete agreements are a matter of public policy in Pennsylvania, the court will balance the employer’s need for the noncompete against the public’s interest.  Hess, 570 Pa. at 157-60, 808 A.2d at 917-18.

Pennsylvania Legitimate Business Interest - Goodwill

The interest protected under the umbrella of goodwill is a business’s positive reputation and customer relationships.  Hess 570 Pa. at 165, 808 A.2d at 922 (citing Solomon v. Solomon, 531 Pa. 113, 611 A.2d 686, 692 (1992)).  “Goodwill represents a preexisting relationship arising from a continuous course of business which is expected to continue indefinitely.”  Butler v. Butler, 541 Pa. 364, 372 n. 9, 663 A.2d 148, 152 n. 9 (1995). A business's goodwill is considered a protectable interest even when the goodwill has been acquired through the efforts of an employee.  Sidco Paper, 465 Pa. at 591-93, 351 A.2d at 252-53.  The positive relationships that an employee builds with an employer’s customers, therefore, are legitimate business interests that may be protected by a noncompetition agreement.

Legitimate Business Interest – Pennsylvania Trade Secrets and Confidential Information

A second set of protectable interests recognized in Pennsylvania is trade secrets and confidential information.  Wellspan Health v. Bayliss, 2005 Pa. Super 76, p. 21 (Pa. Super 2005).  Pennsylvania recently adopted the Uniform Trade Secrets Act, 12 Pa.C.S. § 5301, et seq., (“UTSA”) which codified much existing common law and which defines trade secrets as:

 12 Pa.C.S. § 5302.  Historically, prior to the adoption of the UTSA, a trade secret did not include an employee's aptitude, skill, dexterity, manual and mental ability, or other subjective knowledge.  Pittsburgh Cut Wire Co. v. Sufrin, 350 Pa. 31, 35, 38 A.2d 33, 34 (Pa. 1944).  There is no indication that the UTSA has changed this exclusion.  In addition, if a competitor could obtain the information by legitimate means, it will not be given injunctive protection as a trade secret. Tyson Metal Products, Inc. v. McCann, 376

posted by Christopher Ezold  |  Aug 3, 2009 10:13 AM [EST]  |  applies to Pennsylvania