In a highly anticipated decision, the Pennsylvania Supreme Court ruled earlier this week that “new and valuable” consideration must be conveyed to an employee entering into an agreement containing a restrictive covenant after the initiation of employment, and that contractual language established by statute as a substitute for consideration does not satisfy that requirement. In Socko v. Mid-Atlantic Systems of CPA, Inc., No. 142 MAP 2014, 2015 Pa. LEXIS 2672 (Pa. November 18, 2015), the Supreme Court affirmed the Pennsylvania Superior Court’s 2014 holding that including a statement in a restrictive covenant agreement that the parties “intend to be legally bound” – while recognized as providing sufficient consideration to support enforcement of agreements under Pennsylvania’s Uniform Written Obligations Act, 33 P.S. § 6 (UWOA) – did not satisfy the “valuable” consideration requirement.
Approximately a year-and-a-half after entering into employment with Mid-Atlantic, Mr. Socko signed an employment contract containing a two-year covenant not to compete. It was undisputed that Mr. Socko did not receive any benefit or beneficial change in his employment status in exchange for signing the non-compete agreement. After resigning from Mid-Atlantic, Mr. Socko commenced a declaratory judgment action seeking a determination that the restrictive covenant was unenforceable on the basis that it was not supported by sufficient consideration. In response, Mid-Atlantic contended that the inclusion of “intending to be legally bound” language in the agreement served to bar Mr. Socko from challenging the validity of the agreement on the basis of a lack of consideration.
Mid-Atlantic based its argument on the UWOA, which provides that “[a] written release or promise, hereafter made and signed by the person releasing or promising, 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.” 33 P.S. § 6. Pennsylvania courts have interpreted this section to provide that a written agreement shall not be void for lack of consideration if it contains the requisite statement. A number of older decisions from the Pennsylvania Courts of Common Pleas, and more recent decisions from Federal District Courts applying Pennsylvania law, have relied on the UWOA in rejecting arguments that restrictive covenants failed for a lack of consideration. See, e.g., Latuszewski v. Valic Fin. Advisors, Inc., Civil Action No. 03-0540, 2007 WL 4462739 (W.D. Pa. Dec. 19, 2007).
Rejecting Mid-Atlantic’s argument, the Socko court focused on the interplay between the historic treatment of restrictive covenants under Pennsylvania law and a statutory interpretation of the UWOA. The Court noted that Pennsylvania courts historically disfavored restrictive covenants as restraints of trade. Nevertheless, covenants not to compete in employment agreements were enforceable if they adhered to certain requirements, including that they be consummated with the exchange of consideration. While the initial award of employment provides sufficient consideration, if the restrictive covenant is sought after employment has commenced, it is enforceable only if the employee receives new and valuable consideration; i.e., some corresponding benefit or a favorable change in employee status. Under Pennsylvania law, the mere continuation of employment is insufficient to serve as consideration for the new covenant.
In determining the intent of the Pennsylvania General Assembly with respect to the UWOA, the Supreme Court first rejected Mid-Atlantic’s argument that the “intending to be legally bound” language did not act as a substitute for consideration, but instead precluded the signer from challenging the agreement on the basis of lack of consideration. Next, although the UWOA language could serve as a substitute for consideration, the Court found that it would be unreasonable to construe the UWOA in a manner that vitiated the common law requirement for new and valuable consideration when entering into a restrictive covenant after the initiation of employment. Finally, the Court held that its obligation to strictly construe the UWOA buttressed its determination that the statute should not be read to vitiate the need for new and valuable consideration. Thus, the Court concluded that an employment agreement containing a restrictive covenant not to compete may be challenged for a lack of consideration even though the agreement, by its express terms, provides that the parties “intend to be legally bound” pursuant to the UWOA.
While holding that the language of the UWOA did not satisfy the requirement for “new and valuable” consideration, the Court did not address what specifically will satisfy that requirement when a restrictive covenant is entered into after the commencement of employment. As a result, companies that rely on restrictive covenants to protect their business should seek guidance regarding the sufficiency of the consideration provided through their agreements, particularly if those agreements rely upon the “intending to be legally bound” language.
Reed Smith attorneys have extensive experience reviewing and auditing the enforceability of restrictive covenants and advising clients on a variety of methods to establish the consideration necessary to support such agreements. If you have any questions about the Socko decision, or regarding the implementation and enforcement of restrictive covenants, please contact the authors of this Alert or the Reed Smith attorney with whom you work.
Client Alert 2015-323