Pennsylvania Appellate Court Finds Uniform Written Obligations Act Inapplicable to Covenants Not to Compete
In a case of first impression, the Pennsylvania Superior Court (one of Pennsylvania’s two state appellate courts) recently issued a ruling in Socko v. Mid-Atlantic Systems of CPA, Inc. (“Socko”), 1223 MDA 2013 (May 13, 2014), clarifying that compliance with Pennsylvania’s Uniform Written Obligations Act (“UWOA”) cannot cure a deficiency in the adequacy of the consideration necessary for an enforceable covenant not to compete.
Pennsylvania’s UWOA provides that a signed, written agreement cannot be found to be invalid for lack of consideration if the agreement includes language indicating that “the signer intends to be legally bound.” 33 Pa. Stat. § 6. Before the Socko decision, there were conflicting decisions issued by federal courts sitting in Pennsylvania regarding the applicability of the UWOA to covenants not to compete. Compare Surgical Sales Corp. v. Paugh, 1992 WL 70415 (E.D.Pa. March 31, 1992) (finding that the UWOA does not permit enforcement of a restrictive covenant in the absence of consideration), with Latuszewski v. Valic Financial Advisors, Inc., 2007 WL 4462739 (W.D.Pa. Dec. 19, 2007) (finding that UWOA permits the enforcement of a restrictive covenant in the absence of consideration).
Like most states, Pennsylvania historically has disfavored covenants not to compete in the context of employment situations. Pennsylvania courts, however, will enforce non-compete agreements in certain circumstances. The requirements for an enforceable non-compete in Pennsylvania are: (1) the covenant must be ancillary to either a contract for the sale of goodwill or other subject property or to a contract of employment; (2) the covenant must be supported by adequate consideration; and (3) the application of the covenant must be reasonably limited in both time and territory. Maintenance Specialties, Inc. v. Gottus, 314 A.2d 279, 282 (Pa. 1974) (Jones, C.J., concurring). Under existing Pennsylvania case law, continued employment is not adequate consideration to support a covenant not to compete ancillary to a contract of employment without there also being a corresponding benefit or change in status for the employee. Accordingly, a covenant not to compete is valid and enforceable with respect to employees only if (1) it is entered into at the beginning of the employment relationship or (2) it is entered into in connection with the receipt of an additional benefit to which the employee is not already entitled or a change in employment status.
The facts of the Socko case present an interesting and cautionary tale for employers. The parties actually entered into an employment agreement containing a covenant not to compete at the inception of the employment relationship. However, they subsequently executed a new employment agreement, which contained a non-competition covenant and which provided that it superseded all prior agreements between the employer and employee. The court found that the new non-compete covenant was invalid because the employment agreement superseded the prior agreement and contained a new non-compete that was not supported by additional consideration.
Relying on language in the employment agreement indicating that it was the intent of the parties to be legally bound by the terms of agreement, the employer argued that, under the UWOA, the non-compete could not be invalidated for lack of adequate consideration. However, the court rejected the employer’s argument and held that the UWOA does not apply in this context. In so holding, the court relied heavily on the fact that, while courts will not generally examine the adequacy of consideration involved in most written agreements, they will do so when considering whether to enforce a non-compete covenant.
This new Pennsylvania appellate decision represents one more example of the heightened scrutiny that courts will apply to covenants not to compete and highlights the need for employers to exercise caution when entering into new, updated or amended employment agreements with employees whose original agreements might have contained restrictive covenants—particularly if the employee works in a state like Pennsylvania, which views continued employment as insufficient consideration to support a covenant not to compete.