Through its decision in Socko v. Mid-Atlantic Systems of CPA, Inc., No. 1223, 2014 WL 1898584 (Pa. Super. Ct. May 13, 2014), the Pennsylvania Superior Court has confirmed that a restrictive covenant entered into after the commencement of employment will not be enforced unless “valuable” consideration was provided to the employee in exchange for the agreement. In doing so, the court, in a matter of first impression in Pennsylvania, held that inclusion of a statement in the restrictive covenant 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) – does not satisfy the “valuable” consideration requirement.
The facts of the Socko case are straightforward: 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. Instead, Mid-Atlantic argued that inclusion of “intending to be legally bound” language in the agreement satisfied the consideration requirement.
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 Financial Advisors, Inc., Civ. A. No. 03-0540, 2007 WL 4462739 (W.D. Pa. Dec. 19, 2007).
In rejecting this approach, the Socko court reviewed the historic treatment of restrictive covenants under Pennsylvania law. It had long been the rule that contracts in restraint of trade made independently of a sale of a business or contract of employment were deemed void as against public policy. During the 1960s and 1970s, however, the Pennsylvania Supreme Court relaxed this requirement through a series of cases holding that a restrictive covenant entered into after initial employment was enforceable where “valuable” consideration was provided in support of the agreement.
The Socko court found the “valuable” consideration requirement significant. Whereas Pennsylvania courts have historically held that the existence of consideration is a necessary element for an enforceable contract, the adequacy of that consideration is typically not a factor that courts will consider in determining whether a contract is enforceable. In the restrictive covenant context, however, Pennsylvania courts have rejected as inadequate various forms of consideration that would support the enforcement of other types of contracts, including the benefit of continuation of at-will employment; nominal consideration (e.g., $1.00); and the fact that a contract was made “under seal” (another legal substitute for consideration). Thus, in order to support a restrictive covenant entered into after the commencement of employment, the consideration for that agreement must be shown not only to have existed, but also to have been adequate. The Socko court held that while the language of the UWOA may have the effect of imparting consideration into a contract, satisfying the need to prove the existence of consideration, it does not confer a benefit upon the restricted party.
Summarizing its holding, the court stated: “[w]hen the restrictive covenant is contained in the initial contract of employment, the consideration is the job itself. But when the restrictive covenant is added to an existing employment relationship, however, to restrict himself the employee must receive the corresponding benefit or change in job status.” While the “legally intending to be bound” language in Mr. Socko’s contract may have satisfied the requirements of the UWOA, it did not provide him with any actual benefit and therefore could not support enforcement of the restrictive covenant.
The question left unanswered by the Socko decision is what consideration will be deemed adequate to support a restrictive covenant entered into after the commencement of employment. While the case law provides some guidance, this is a particularly case-specific inquiry that requires a court to weigh a variety of factors, including the nature of the benefit conveyed to the employee, as well as the scope and duration of the restrictive covenant. As such, before attempting to implement a restrictive covenant for existing employees, it is important to consult with counsel for an assessment as to the adequacy of the proposed consideration. You do not want to learn on the day that you seek to enforce the covenant that the consideration conveyed to the employee was inadequate.
If you have any questions about the implementation and enforcement of restrictive covenants, or specifically about the Socko decision, please contact the authors of this Alert or the Reed Smith attorney with whom you routinely work.
Client Alert 2014-134