Noncompetition Agreements can be entered into in a few different situations. Often an employer will require an employee to sign a Noncompetition Agreement. The same situation can occur when a company requires an independent contractor to enter into a Noncompetition Agreement.
Another common circumstance where a party will agree not to compete is when a company sells its business. The buyer will most likely require that the seller agrees as part of the acquisition agreement, that it will not start another business that competes with the business that was sold.
Under Pennsylvania law, when an employee or an independent contract agrees not to compete with the employer’s business or the independent contractor agrees not to compete with the company that has hired the independent contractor, there are a couple of things the Pennsylvania courts will look at to determine whether the noncompetition agreement is enforceable. First, there must be adequate compensation for the agreement not to compete. Pennsylvania law considers agreements not to compete that are executed at the time an employment agreement or independent contractor agreement is signed, to meet the test for adequate compensation. If the agreement not to compete is entered into after the date of the employment agreement or independent contractor agreement, there is inadequate consideration.
If an employer or business engaging an independent contractor wants an employee or independent contractor to execute a noncompetition agreement after the date of the employment agreement (or date employment begins) or independent contractor agreement, there must be compensation paid in order for the agreement not to compete to be enforceable. For employees, many companies will issue stock options as consideration for the noncompete. A company hiring an independent contractor can also offer stock options. In both cases, adequate cash compensation may also be offered in lieu of stock options.
Noncompetition agreements are usually contained in in acquisition agreements. In Pennsylvania, this is enforceable with respect to meeting the adequate consideration test.
Scope of Noncompetition Agreement
Generally speaking, Pennsylvania does not look favorably on noncompetition agreements that are entered into in connection with employment or as an independent contractor. Pennsylvania views such agreements not to compete as having the potential from limiting the person’s ability to earn a living. With that being said, when drafting a noncompetition clause, it should be restricted to the geographic scope in which the company actually conducts business. If the company only conducts business in Pennsylvania but includes a noncompetition provision prohibiting the employee from competing anywhere in the United States, this is likely not enforceable. The lawyer should restrict the scope of the noncompetition provision to the area where the employer conducts business. In addition, it is always a good drafting practice to include a provision that states that to the extent any provision of the agreement (which would include the agreement not to compete) is unenforceable because it is too broad, the applicable provision should be narrowed by the court to the extent it is enforceable.
Noncompetition agreements entered into in connection with the sale of a business should also cover the geographic area where the business currently operates or where it has an intention to operate.
Pennsylvania is stricter on the time period that a noncompetition agreement is enforceable in connection with employees and independent contractors than it is in connection with the sale of a business. This stems from the fact that Pennsylvania courts do not want to restrict a person from working. Typically, a two-year agreement not to compete will be upheld and often three-year terms will be upheld.
Noncompetition agreements are very important to businesses, so taking the time to ensure they are enforceable by following the steps laid out above is worth the effort. A business should engage a business attorney to draft the noncompetition agreement and ensure it is enforceable.