By Patricia C. Collins, Esquire
Reprinted with permission from May 30, 2014 issue of The Legal Intelligencer. (c)
2014 ALM Media Propeties. Further duplication without permission is prohibited.
In Socko v. Mid-Atlantic Systems of CPA, Inc., the Pennsylvania Superior Court reconfirmed Pennsylvania’s laws regarding consideration for restrictive covenants, and refused to allow a technicality to cure an otherwise defective restrictive covenant. The Court rejected the employer’s argument that the use of the phrase “intending to be legally bound” in a restrictive covenant supplied adequate consideration for enforcement of a covenant executed after the taking of employment. In doing so, the Court relied on the historical treatment of restrictive covenants by Pennsylvania courts, confirming that such agreements are disfavored.
The facts are these: Socko signed a two-year covenant not to compete at the beginning of his employment with Mid-Atlantic. Over a year later, Socko signed another employment contract with a different two-year restriction on competition. This agreement, by its language, superseded the previous agreement. Socko did not receive a raise, a bonus, or any other consideration to support the new restrictive covenant. Socko then resigned from Mid-Atlantic and took a position with a competitor. Mid-Atlantic notified the new employer of the existence of the restrictive covenant, and the new employer terminated Socko. Socko then filed suit, seeking a declaratory judgment that the restrictive covenant was unenforceable because it was not supported by adequate consideration.
Mid-Atlantic conceded that this restrictive covenant was not executed with the taking of employment. Mid-Atlantic also conceded that Socko received no raise, promotion, bonus or other consideration for the new restrictive covenant, and argued that consideration was supplied by the use of the phrase “intending to be legally bound” in the employment agreement. Under the Uniform Written Obligations Act, 33 P.S. § 6, the argument goes, Socko could not avoid the obligations of the written restrictive covenant for lack of consideration because it contained the phrase “intending to be legally bound.”
Both the trial court and the Superior Court rejected the employer’s argument. The Superior Court relied on the fact that such agreements are disfavored under Pennsylvania law, and noted that the law treats these contracts differently. The Court noted that such agreements are disfavored for two reasons: they are restraints on trade, and they limit the ability of the employee to earn a living. The Court recited the history of restrictive covenant jurisprudence and reiterated the applicable rules: the taking of new employment will provide adequate consideration for a restrictive covenant, but any restrictive covenant signed after the taking of employment must be supported by valuable consideration. The Court evaluated the case law to find that courts have rejected the argument that execution of such an agreement “under seal,” or the provision of nominal consideration ($1.00) will provide adequate consideration for a restrictive covenant signed after the taking of employment.
The Court noted that the case law requires “valuable consideration” and a “corresponding benefit” for restrictive covenants signed after the beginning of employment. In this way, restrictive covenants are different from other contracts: while a court will not question the adequacy of consideration in the enforcement of a contract, the court is free to evaluate whether consideration is “valuable” in the context of a restrictive covenant. Where continued employment, contracts under seal, and nominal consideration would suffice for other contracts, courts are free to reject the proffered consideration as inadequate where it is asked to enforce a restrictive covenant executed after the inception of employment.
Accordingly, at issue in the litigation of restrictive covenants signed after employment has begun is whether the bonus, promotion or other consideration provided is “valuable” or “corresponds” to the agreement to restrict oneself from competition. Given the Court’s observation that such agreements cause significant hardship for employees agreeing to them, it will be interesting to see what consideration would suffice to support the covenant.
The case presents other litigation problems related to restrictive covenants. Many employers update or revise the terms of their restrictive covenants, or require employees to take on new restrictions as they climb the corporate ladder. Where the new agreement “supersedes” the old agreement, as it did in this case, without adequate consideration the employer will be left with no restrictions at all. In this way, the issues in litigation will include whether or not the new agreement supersedes the old agreement.
The court did not evaluate whether or not the employee stated a claim for tortious interference with his business relationship with the new employer. To state such a claim, the employee would have to show, inter alia, that the employer had no privilege to act, and that the employer interfered for the purpose of harming the employee. Prior to this ruling, perhaps the argument regarding whether the Uniform Written Obligations Act provided sufficient consideration would have shielded the employer from such a claim; however, this ruling could make such a claim viable for the employee, provided the other elements of the claim are met. Reliance on a technicality to shield the employer from a tortious interference claim may not be the best course after the decision in Socko.
The Socko opinion does not mark a departure from previous jurisprudence on the enforcement of restrictive covenants. Instead, the opinion confirms what those who litigate restrictive covenants see in their practice: courts are reluctant to enforce them, and will not do so on the basis of a technical argument. In this way, much depends on what happened before litigation: the language of the agreement, the consideration provided, the employee’s job duties, and the nature of the employer’s business and the former employee’s competition. Indeed, an employee who signs an agreement stating that he “intends to be legally bound” may not be, and employers should be careful, before suing, that they are not at risk for a claim of tortious interference.
Patricia Collins is a Partner with Antheil Maslow & MacMinn, LLP, based in Doylestown, PA, with a branch office in Princeton, NJ. Her practice focuses primarily on commercial litigation, employment and health care law.