Thursday, December 8, 2011

NON-COMPETE COVENANTS: REASONABLE RESTRICTIONS OR UNREASONABLE RESTRAINTS OF TRADE?

Non-competition covenants – agreements by which employers seek to contractually restrict employees from later working for a competitive business, often for a year or two after leaving their current employment – are an ever-increasing part of the business landscape. Historically, these covenants were legitimately used to provide employers with critical protections against the taking of important parts of their business by key employees. More recently, however, the blanket and indiscriminate use of these covenants to bind all sorts of employees, from CEOs to entry-level sales representatives, has become an increasingly onerous and unreasonable limitation upon the activities of both employers and employees alike.


Non-competition covenants are, by their very nature, restraints on trade, contrary to the basic notions of the American free-market system. When properly used to prevent an employee from taking an employer’s trade secrets and using those secrets for the benefit of a subsequent employer, non-competition covenants can provide valuable and legitimate protection. However, these protections can almost always be provided with more narrowly written restrictions against the use of trade secrets and non-solicitation covenants.


The persistent and increasing use of non-competition covenants for non-key employees, and employees without the recipe to the “secret sauce,” is increasingly creating unreasonable restraints on trade, without actually protecting any legitimate interest of employers. In these cases, the primary effect, and sometimes the far more questionable and pernicious goal of the covenants, is to simply prevent employees from leaving their current employer rather than protecting that employer from legitimate risks of unfair competition after they leave.


This trend creates problems not just for the employees who are unable to take jobs in the only industries they know, but also for prospective employers who customarily must ask, in the current climate of non-competition covenant overuse and abuse, whether their prospective hires are bound by non-competition covenants. Increasingly, employers cannot hire experienced employees because those experienced employees are routinely bound, for a year or two or more, by questionable non-competition covenants.


Generally speaking a non-competition covenant is enforceable under Pennsylvania law if it was signed at the start of employment. And while continued employment is generally not sufficient consideration for a non-competition covenant signed well after the start of employment, covenants signed after the start of employment will be binding if the employee was given some additional consideration for signing that covenant after the start of employment. Non-competition covenants signed after the start of employment will often be deemed binding even where the additional consideration given is questionable or illusory, as where a company with no discernible stock value or no prospect for increased stock value awards an employee essentially worthless stock options in consideration for signing a non-compete covenant.


However, even though a non-competition covenant is theoretically enforceable if an employee receives some consideration for its signing, it is not always the case that a court will actually enforce that covenant. In the context of a request for an injunction to enjoin an employee from competing with the former employer, a court should not and generally will not enforce a non-competition covenant unless the former employer can establish that the employee’s competition is actually causing the former employer irreparable harm. Otherwise, the sole effect of the covenant (and often the primary motive to have such covenants signed in the first place) is to simply prevent an employee from leaving employment, which is plainly not a legitimate purpose for non-competition covenant under Pennsylvania law. The guiding principle of law is that non-competition covenants are restraints on trade and on the ability of a worker to earn a living, and are therefore not favored by the law. As a result, such covenants will not be enforced except to the extent necessary to prevent significant harm to the employer.


For employees who possess no particular trade secrets and who can cause the employer no harm beyond the short-term disruption that inevitably follows when an employee quits a job, the primary effect of a non-competition covenant is to prevent an employee from ever leaving employment, thus requiring that employee to put up with whatever pay cuts or onerous job restrictions the employer may seek to impose. Plainly in that case, the non-competition covenant limits the employee’s future job prospects while serving no compelling interest of the employer. In all likelihood, no court would enforce a non-compete covenant with an injunction under those circumstances.


Even so, the very existence of that non-competition covenant, however unenforceable, may be enough to scare off other prospective employers, particularly in the current economy – unquestionably an employer’s market. That is, given a choice between two equally qualified employment prospects, one of which is saddled with a non-compete and the other of which isn’t, a prospective employer is likely to avoid hiring the restricted employee and the associated headaches of having to deal with a possible lawsuit, and instead hire the unrestricted free agent.


What goes around comes around. The employer who gets the benefit of a non-competition covenant this year may be the employer looking to hire someone bound by a non-competition next year. For this reason, and also in order to not unnecessarily restrict the freedom of individual workers, employers may be well advised to reconsider the blanket use of non-competition covenants, and instead consider using less restrictive employment agreements, such as covenants restricting solicitation of customers and fellow employees, and covenants against the use of trade secrets. Not only are these covenants less burdensome and often more reasonable than non-competition covenants, they are also more likely to be enforced by a court, precisely because they are less burdensome and more reasonable. Employers and employees seeking advice on restrictive covenants should contact experienced legal counsel.

Wolf, Baldwin & Associates, P.C. is a general practice law firm in Pottstown, PA, founded by Jack F. Wolf in 1972. The firm’s areas of practice include Workers’ Compensation matters, Business and Corporate Law, Family Law, Estate Planning, Estate Administration and Probate, Real Estate, and General Civil Litigation. For more information, call 610-323-7436 or visit the firm’s website at www.wolfbaldwin.com.

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