• Non-Competes: Are They Worth The Paper They Are Written On?
  • November 6, 2003 | Author: Alan R. Boynton
  • Law Firm: McNees Wallace & Nurick LLC - Harrisburg Office
  • The ability of employers to restrict their employees from competing with them after termination of employment is a subject on which many have strong feelings. Some employers swear by non-compete agreements as an infallible weapon while others believe that they are not worth the paper on which they are written. The correct answer, not surprisingly, lies somewhere in the middle.

    Prior to discussing specifics of enforceability, a brief primer on the tensions which have created the rules governing non-compete is probably of some use. Non-compete agreements fall into the gray area between an employee's right to seek and obtain gainful employment in the field of his expertise, an employer's right to protect his business investments and relationships, and a societal desire to enforce freely entered into contracts between two parties. These often conflicting tensions are not easily resolved and the resulting court decisions often seem inconsistent, if not contradictory. Employers can take solace, however, in the fact that certain patterns have emerged and certain fairly firm rules developed which should provide fairly strong assurances of enforcement of such agreements if they meet the established criteria.

    At the outset, it should be recognized that courts are loath to prevent a person from seeking employment of his choosing. They will reluctantly do so if (1) the agreement is supported by consideration; (2) the restrictions are reasonable; and (3) enforcement is necessary to protect an employer's legitimate interests. There are other factors and facts which can torpedo efforts at enforcement but, if an employer can meet these three requirements, the odds are fairly good that the agreement will be enforced. Therefore, at least a cursory examination of each would be of some use.

    Consideration: The term "consideration" is a legal one. In layman's terms, since an employee is traditionally free to work for whomever he chooses, he must be given something in return for restricting that right. An agreement of any kind is enforceable only if both sides provide something, known as "consideration," to each other. Since the right to choose one's own employment is considered an important one, the consideration given by the employer to restrict that right must be substantive. It cannot be illusory or nominal.

    There are generally considered two forms of consideration which would support a non-compete agreement. The first is an offer of employment made conditional on the employee agreeing to a non-compete. To be enforceable, the condition must be conveyed to the prospective employee prior to his acceptance of employment. Once the employee shows up for his first day of work, it is too late to rely on this type of consideration. Courts have determined that employers may not spring a non-compete agreement on an employee after he has started employment and then rely on the offer of employment as the consideration.

    The second form of consideration is that given after the employee starts to work for the employer. That consideration can take several forms: a promotion to a position with more responsibilities and/or one with potentially greater compensation is satisfactory. A cash payment of sufficient amount (anything over $1,000 is usually sufficient; anything under $500 is likely not sufficient, and anything in between $500 and $1,000 is questionable). The cash payment cannot be part of a regularly scheduled raise or bonus.

    What lessons can be learned from the above? Two stand out: (1) an employer should always include in a letter offering employment the statement that the employer will be required to execute a non-compete agreement (he agreement itself can be signed after the employee starts work; it is the discussion requiring such agreement for which the timing is critical)., and (2) every time an employee receives a promotion, he should be required to sign a new non-compete agreement. As an alternative to the first point, an employer should document the fact that there was a discussion prior to hiring that the employee would be required to sign a non-compete. Absent such documentation, proof of such discussion often becomes a question of credibility and courts are reluctant to restrict the ability of ex-employees to work absent fairly strong evidence.

    Reasonableness: If an agreement is supported by consideration, the court will next look to the reasonableness or fairness of the terms. Employers may properly ask why a court would do that. After all, when companies or individuals make agreements with each other, courts will not usually look at them to assess whether one party got a bad deal before enforcing it. Whether a party negotiated a poor deal is usually not an issue for a court to decide. Where, however, a party seeks the court to order something to occur, the party is appealing to the "equity" power of the court. When a court exercises that power, it must look to the fairness of what it is going to do, even in contract settings. Of course, if the ex-employer is simply seeking damages, and not an injunction, the court is not to look at the equities but must focus on basic contract principles. This discussion, however, is focused on an ex-employer who wishes to get an injunction to enforce the terms of the non-compete agreement.

    The issue of fairness is particularly applicable where the tensions discussed above come into play. In particular, courts recognize that employees rarely are on an equal plane as an employer when it comes to negotiating terms of employer. They are also very reluctant to restrict an employee's right to work unless the restrictions are reasonable.

    Reasonableness is often in the eye of the beholder. What seems perfectly reasonable to an employer may seem outrageous to an employee, and vice versa. In this setting, courts look to whether the imposed restrictions are reasonable in time and geographic scope. Typically, a two-year restriction is upheld in Pennsylvania. However, in industries where technologies are changing rapidly, restrictions of a year may be considered unreasonable. When dealing with sales personnel, the key factor is how long it will take the ex-employer to train a new salesperson and have that individual in place and with a relationship with customers so that the ex-employer can compete for the customer's work on a level playing field.

    Geographically, restrictions can be as little as five miles (as is the case in some local pizza shops) or worldwide (as in companies such as Hershey Foods). The key determinant is the work performed by the ex-employee. The agreement will likely be enforced as broadly and narrowly necessary to prevent him from gaining an unfair advantage from his prior employment. An alternative to a specific geographic limitation is a non-solicitation provision limited to customers or accounts handled by the ex-employer during his employment. Such a limitation is narrowly focused and often much easier to enforce than a specified geographic area.

    Necessary To Protect The Legitimate Interests Of The Employer: This factor ties in closely to the reasonableness one discussed above. Courts will not allow ex-employers to arbitrarily enforce restrictions if such enforcement will not benefit the ex-employer.

    One area where this factor comes into play is that of the incompetent employee. If that person is terminated for failure to perform adequately, courts will likely not enforce a non-compete signed by that employee. The rationale is that, if the employee is so bad that he must be terminated, then he is not good enough to harm the employer as a competitor.

    Change Of Employers: One final aspect of non-competes should at least be touched on, although this topic could form the subject of a book in itself, is that of the change of employers. In today's business climate, where businesses are regularly bought, sold, merged, consolidated, etc., an employee may sign a non-compete with one entity and end up working for several successors, without ever changing responsibilities, supervisors or customers. Joe Smith may have signed a non-compete not to compete against Acme Electronics. What happens when Acme is bought by Microsoft? Is the original non-compete enforceable? If there is no provision in the non-compete authorizing the employer to assign it, probably not. Microsoft would be required to have the employee sign a new agreement.

    This situation can be a real problem for small companies which rely heavily upon a few employees and when the value of the business to be sold may be dependent upon retaining those employees. Absent an assignment provision in the non-compete, the ability to prevent competition by those employees may not exist. Thus, non-compete agreements should always contain such provisions.

    So, what is the final answer? Are non-competes enforceable? Are they useful? Are they worth the paper they are printed on? The answers are yes, yes and yes again, if the employer pays attention to details and uses an agreement appropriate to the circumstances. Indeed, any employer which does not use non-competes to protect its assets may be handicapping its ability to compete. In today's market, that may not be a good business strategy.