The Pennsylvania Supreme Court spoke to the issue of the required consideration for restrictive covenants in employment contracting in Rullex Co., LLC v. Tel-Stream, Inc. The Court was tasked with determining whether a non-compete agreement that was signed by the parties after employment began was enforceable.
It assessed whether a non-compete agreement was enforceable when there was no evidence of new consideration with the execution of the agreement. The Court held that new consideration is required for any additional covenants added to an employment agreement after the initial employment has begun when sufficient consideration could not be established for those covenants in the initial agreement.
The case began when Tel-Stream, a company that does maintenance work for cell towers, was contracted by Rullex, a technology company that provides services for major cell phone companies. Invertice was Rullex’s main competitor, which led them to seek a non-compete agreement with Tel-Stream that Tel-Stream would not work with Rullex’s competitors for at least 24 months after working for Rullex.
The issue arose because Tel-Stream’s initial employment agreement was signed and executed prior to the addition of the non-compete clause. While Rullex insisted that the non-compete was discussed during the contracting process, it was not actually signed until at least two months into Tel-Stream’s work.
The Court in this case discussed how courts in the past have handled the enforceability of restrictive covenants. It acknowledged that, traditionally, “events can move faster than paper” in the business world. For this reason, even when a restrictive covenant like a non-compete agreement was not executed on the first day of work, Pennsylvania courts have found such covenants enforceable even when there was no new consideration.
This was only appropriate, however, when both of the parties understood that such a covenant would be part of the overall arrangement at the beginning of the employment. In fact, the Court stated that a restrictive covenant that was executed on the first day of work could be unenforceable if the parties had a binding oral agreement for employment that did not account for that covenant. The test for whether new consideration for a restrictive covenant is required, therefore, does not relate necessarily to whether the employee completed the agreement on or before the first day of employment.
The reason the court has included a test for “fresh” consideration in certain cases is to protect employees from having additional burdens imposed on them as a result of an employment relationship. This test is meant to ensure that any restrictive covenants employees must follow are ones to which they have agreed, particularly because courts generally disfavor restrictive covenants. Such covenants are seen as limiting the free market rather than encouraging fluid and productive business.
There has been some confusion regarding this rule for covenants not to compete, however, due to disputes over whether agreements made in negotiations at the start of employment relationships are enforceable when the document is signed subsequent to the beginning of work.
Rullex argued that the need to protect an employee from being burdened by surprise restrictive covenants is irrelevant if the employee is aware that the employer intends to introduce such a covenant. For that reason, Rullex argued that the actual time at which the restrictive covenant is signed does not necessarily matter.
Both parties agreed that Tel-Stream signed the non-compete agreement subsequent to starting work, but the trial court and Superior Court ruled in Tel-Stream’s favor. They held that the non-compete was not enforceable “since it had not been executed before the companies began working together.” Rullex attempted to counter this invalidation by pointing out that the non-compete was drafted prior to the first day of employment, but the appeals court nonetheless was not convinced that this made the agreement enforceable.
Tel-Stream argued that the owner of the company, Yuri Karnei, did not speak English and that prevented him from having a sufficient understanding that the parties would have a restrictive covenant in their agreement.
The Pennsylvania Supreme Court agreed that the non-compete was invalid, and they clarified that there could not have been a sufficient meeting of the minds to allow this covenant to be enforceable based on consideration from before the contract’s execution. There was also insufficient evidence of new consideration after the employment began and before the agreement was signed. In doing so, they offered valuable clarification on what is required for proper consideration for the enforcement of restrictive covenants. Thus, the Court concluded, “for a restrictive covenant executed after the first day of employment to be enforceable absent new consideration, the parties must have agreed to its essential provisions as of the beginning of the employment relationship.”
Benjamin C. Dunlap, Jr. is managing partner at Nauman Smith, a Harrisburg-based law firm, and concentrates his practice on business and employment law. With contribution from Jacqueline Stryker, J.D. candidate, Penn State Dickinson Law.