United States: Pennsylvania Supreme Court Rules That Continued Employment Is Not Sufficient Consideration For Non-Competes Entered Into After The Employment Relationship Has Begun

In a landmark ruling of first impression, the Pennsylvania Supreme Court recently held that an employer's non-competition covenant, which included the employee's pledge not to challenge the covenant for inadequate consideration, is unenforceable unless it is accompanied by a change in job status or some other significant benefit.  Socko v. Mid-Atlantic Systems of CPA, Inc., Case No. 3-40-2015 (Nov. 18, 2015), aff'g 2014 Pa. Super. 103 (May 13, 2014), which affirmed 2012 WL 12248901 (Pa. Com. Pl., Oct. 17, 2012).

The non-competes.  Socko was a salesman for Mid-Atlantic, a basement waterproofing company.  In 2007 and 2009, he signed two-year employment agreements each of which contained a non-competition covenant for two years after termination.  In 2010, Mid-Atlantic required him to sign a third non-compete.  It was more restrictive, expressly superseded the other two, and prohibited competition for two years anywhere Mid-Atlantic did business.

The lawsuit.  Shortly after resigning in January 2012, Socko became employed by a competitor.  When Mid-Atlantic provided to the new employer a copy of his third non-compete covenant, Socko was discharged.  He sued Mid-Atlantic and sought, among other relief, a declaratory judgment that the covenant was unenforceable for lack of consideration.

Pennsylvania's Uniform Written Obligations Act ("UWOA").  Pennsylvania's Uniform Written Obligations Act ("UWOA") provides that an agreement in writing "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."  Significantly, Socko's third non-compete contained the parties' express commitment to be "legally bound."

Lower courts' rulings.  Relying on a 1991 Pennsylvania mid-level appellate decision which invalidated a restrictive covenant executed by an employee who received no benefit other than continuing employment, the trial court held that Socko's covenant was invalid.  Mid-Atlantic appealed, but to no avail.  The appellate tribunal observed that a contract without benefit to one of the parties but signed under "seal" has been deemed to be invalid for lack of adequate consideration.  The court reasoned that an agreement's inclusion of the intent "to be legally bound" language in the UWOA provided Socko with no benefit more valuable than a seal.  Therefore, the covenant was unenforceable for lack of consideration.  Mid-Atlantic appealed to the Supreme Court.

Arguments in the Supreme Court.  Mid-Atlantic stressed that, as a matter of law, the UWOA barred Socko from challenging the validity of the covenant for inadequate consideration.  Asserting that the statute is unambiguous and contains no exceptions, Mid-Atlantic insisted that the lower courts' rulings in Socko's favor effectively constituted amending the UWOA, thereby legislating under the guise of statutory interpretation.  Socko countered that Mid-Atlantic's contentions ignored the public policy inherent in decisions invalidating restrictive covenants executed after the commencement of employment without substantial benefit to the employee.

The Supreme Court's affirmance, with one Justice dissenting.

Majority decision. The Court said that an exchange of consideration is crucial to the enforceability of all contracts.  Moreover, the analysis of non-compete covenants in the employer-employee context is unique and requires rigorous scrutiny.  Therefore, since the UWOA does not provide expressly that it applies to employment-related covenants, it cannot reasonably be interpreted as abrogating the need for benefits to a continuing employee executing a non-compete.  (This decision does not alter the pre-existing rule that new employment is adequate consideration for a non-compete.  See, e.g., II Malsberger, "Covenants Not to Compete" 4249-55 (10th ed. 2015) (citing Geisinger Clinic v. Di Cuccio, 606 A.2d 509, 513 (Pa. Super. Ct. 1992).)

Dissent. One justice, agreeing with Mid-Atlantic, emphasized that the statute is unambiguous, contains no exemptions, and clearly was made applicable to Socko's employment agreement by inclusion of the "legally bound" phrase.  In the justice's view, Socko forfeited his right to challenge the agreement for lack of consideration.

Takeaways.

First, the decision reaffirms that Pennsylvania law mandates payment of significant consideration to a continuing employee who signs a non-compete.  Otherwise, the covenant is not enforceable.  Similarly, the Adequacy of the consideration for a non-competition promise recently has attracted some courts' attention.  See, e.g., Fifield v. Premier Dealer Services, 993 N.E.2d 938 (Ill. App., 1st Dist., 2013), and its progeny.  

Second, the Pennsylvania Supreme Court seems to have emasculated the present version of the UWOA insofar as it pertains to restrictive covenants signed by employees who receive no benefits.  Perhaps the State's legislature will try to overrule the Socko decision by amending the UWOA. The statute's title, Uniform Written Obligations Act, appears to be a misnomer because it is the law only in Pennsylvania.

Third, Socko apparently was not a high level Mid-Atlantic employee who possessed the company's trade secrets, or an employee who had been trained by the company at considerable expense.  Thus, by attempting to enforce the non-compete, Mid-Atlantic was likely seeking to avoid ordinary competition.  Perhaps different facts would have led to a different result.

Fourth, employers with employees in Pennsylvania who have asked existing employees to sign non-competes or are considering doing the same, should evaluate whether consideration was or will be provided for the non-compete to ensure enforcement.

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