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PA Supreme Court Issues New Guidance for Employers Seeking to Enforce Restrictive Covenants

In a case decided on June 16, 2020, the Supreme Court of Pennsylvania held that 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.  Only in this circumstance, the Court found, will the covenant in substance be “ancillary to taking employment.” See Rullex Co., LLC v. Tel-Stream, Inc. and Yuri Karnei, 2020 WL 3244343 (Pa. 2020).

Rullex Co., LLC (“Rullex”) performs contracting work for telecommunications businesses.  Rullex sought enforcement of a non-competition agreement (“NCA”) executed by Yuri Karnei, a former subcontractor with Rullex. Karnei performed work for Rullex from early 2016 through mid-2017. Thereafter, in late 2017, he began subcontracting his services to a competitor of Rullex.  Rullex filed suit in the Court of Common Pleas of Philadelphia County, alleging that Karnei’s work for its competitor violated the terms of the NCA, and sought a preliminary injunction to prevent Karnei from continuing to work for the competitor during the litigation. The preliminary injunction was denied by the Court of Common Pleas. A three-judge panel of the Superior Court affirmed in a memorandum opinion and held that new consideration was needed to render the NCA enforceable since it was undisputed that the NCA was executed after Karnei had already commenced work.

While NCAs are generally disfavored in Pennsylvania because they constitute a restraint on trade that undercuts a former employee’s ability to earn a living, if an NCA is properly drafted, Pennsylvania courts will enforce NCAs. To be enforceable, an NCA must be incident to an employment relationship and supported by adequate consideration.  In addition, an NCA’s restrictions must be reasonably necessary for the protection of the employer’s legitimate business interests and reasonably limited in duration and geographic scope. Where an NCA is executed at the inception of the employment relationship, the position of employment itself can constitute adequate consideration.

The Pennsylvania Supreme Court allowed further appeal primarily to assess the validity of the per se rule applied by the Superior Court whereby any time an NCA is executed after the first day of employment, it must be accompanied by fresh consideration. The Supreme Court considered Rullex’s argument that Pennsylvania courts have found, under limited circumstances, an NCA executed after the first day of work enforceable even absent new consideration. The Court, however, distinguished those cases based on evidence that the parties had contemplated and intended that the employee be bound by the NCA’s substantive terms at the inception of his or her employment and that the employee signed it shortly after the first day of employment. “For [an NCA] 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. Only in that circumstance will the covenant in substance be ‘ancillary to taking employment’.” Critical to the Supreme Court’s ruling was the testimony of Rullex’s sole witness which established that while Rullex provided Karnei with the NCA before the start of his employment, Rullex gave him time to understand its substance and invited any changes he cared to raise. Although the NCA was ultimately signed without any changes, it was executed two months after the start of employment. Based on these facts, the Supreme Court found, at the time Karnei began working, neither party was bound to the specific terms and obligations of the NCA and, therefore, the NCA could not be enforced without evidence of new consideration.