An appellate court ruling this month serves as a warning to companies with employees in Pennsylvania that noncompetition agreements created after the start of employment are unenforceable, if they were not accompanied by some new consideration or benefit paid to the employee.
In Socko v. Mid-Atlantic Systems of CPA, Inc., a unanimous panel of the Pennsylvania Superior Court affirmed that noncompetition agreements signed after the start of employment must be supported by some new and valuable benefit to the employee to be enforceable under Pennsylvania law. In so ruling, the court rejected a creative argument that the state’s Uniform Written Obligations Act eliminated the need for such consideration.
Under Pennsylvania law, a noncompetition agreement is enforceable only if the contract is either (1) entered into at the start of employment or (2) supported by substantial, new consideration. For employers with agreements that do not meet either of these requirements, steps should be taken promptly to implement new, valid agreements.
The employer in Socko v. Mid-Atlantic Systems of CPA, Inc. admitted that David Socko did not sign the noncompetition agreement at issue until after he had been working at the company for more than a year. Mid-Atlantic also admitted that Socko had not been provided with any new consideration—such as a pay raise, bonus or change in benefits—in exchange for signing the restrictive covenant.
These admissions ultimately doomed Mid-Atlantic’s position. Pennsylvania courts have disfavored noncompetition agreements since at least the 1860s as restraints on trade that prevent employees from earning a living. In particular, the Pennsylvania Supreme Court has held repeatedly that noncompetition agreements in relation to employment are enforceable only if entered into “upon the taking of employment” or supported by “new consideration which could be in the form of a corresponding benefit to the employee or a beneficial change in his employment status.”
Examples of “new consideration” that Pennsylvania courts have approved as supporting a post-employment noncompetition agreement include a pay raise (but not a generally applicable pay raise given to all employees regardless of restrictive covenant), a bonus, a promotion to a new job, the award of stock or stock options, or the granting of a similar, valuable employee benefit.
To get around the admitted lack of new consideration, Mid-Atlantic noted that Pennsylvania’s Uniform Written Obligations Act expressly provides that “[a] written release or promise . . . shall not be invalid or unenforceable for lack of consideration, if the writing also contains an additional express statement, in any form of language, that the signer intends to be legally bound.”
Although the language of the statute appears to state unequivocally that such contract language is a valid substitute for consideration, the appellate court rejected the argument in short order with respect to post-employment restrictive covenants. First, the court noted that restrictive covenants are not like other contracts and involve a restraint on trade and an employee’s ability to earn a living. As such, the Pennsylvania Supreme Court has repeatedly inquired into the “adequacy of consideration,” and held that only “valuable consideration will support their enforcement.” Second, covenants not to compete are the “only exception” to the Pennsylvania rule that a “seal” will serve as a substitute for consideration. Based upon these precedents, the court upheld the continued requirement for valuable consideration.
The ruling suggests several key steps that employers with noncompetition agreements governed by Pennsylvania law (either through choice-of-law provisions, or because the employee works in the state), should take:
- Review the circumstances of existing noncompetition agreements to determine whether they were entered into upon hire, or at a later date.
- For those entered after hiring, the employer should determine whether adequate new consideration was provided.
- If no such new consideration was provided (in other words, the employee was simply required to sign the agreement as a condition of continued employment), the noncompetition agreement is likely unenforceable (while other terms may remain enforceable), and the employer should consider updating the agreement in exchange for new consideration, such as a pay raise, bonus or other valuable benefit.
- Going forward, employers who require noncompetition agreements of certain employees should make the execution of such an agreement a condition of hire, thus avoiding the “new consideration” question altogether.
Michael Homans is a Labor & Employment attorney and founding partner of HomansPeck LLC. For more employment law updates, including news and links to important information pertaining to legal developments that may affect your business, subscribe to Michael’s blog, or follow him on Twitter @EmployLawUpdate.