Top 10 Legal Issues Facing Entrepreneurs in Pennsylvania

Topic 5: Protecting Your Business With Employment Agreements

Introduction

Employment agreements are often utilized by a company to protect its interests against the employees who work there. In addition to setting forth the employee’s wage, benefits, and term of employment, the agreement typically has three additional components for the company’s protection:

1. A non-solicitation provision, where the employee agrees not to solicit the customers or employees of the company for a defined period of time post-employment
2. A non-compete provision, where the employee agrees not to compete with the corporation for a defined period of time post-employment
3. A confidentiality agreement, where the employee agrees not to misappropriate any confidential information of the corporation during or after their employment

An experienced attorney specializing in employment law should be utilized in the formation of any employment agreement, however, this portion of the handbook may be used by entrepreneurs in understanding, planning for, and determining the potential benefits an employment agreement may bring to their company.

Restrictive covenants, such as the provisions outlined above, are an employer’s most important tool in preventing and deterring an ex-employee from harming the employer’s business interests through competitive activity, the release of confidential information and the solicitation of its customers or employees. In this manner, restrictive covenants remain the gatekeeper in protecting customer goodwill and trade secrets which are vital to the employer. On the other hand, without properly drafted restrictive covenants in place, an at-will employee is free to leave employment at any time and to compete with a former employer, as long as the employee does not misuse trade secrets or confidential information, engage in fraud, solicit customers while still employed, or otherwise engage in conduct which is damaging to the employer during their employment term. Therefore, every entrepreneur should have a basic understanding of the following provisions, how they can help protect their business and what restrictions are applicable to each.

The Non-Compete Provision
The non-compete provision typically is utilized to prohibit an employee from the following activity after employment:

• Engaging in business with a customer of the employer
• Engaging in employment or affiliation with an entity that is considered a competitor with the employer

The non-compete restriction may prohibit the employee from competing with the employer during employment¹, but mainly seeks to protect the company from ex-employees. For example, if your company sells cell phone plans, you may require that new employees sign a non-compete agreement, restricting their ability to work for a competitor cell phone company in a defined geographical area and for a set amount of time following termination or leave from your employment.

Restrictions
The major restriction on non-compete provisions in Pennsylvania, like most states, is that it must be reasonable when comparing the interests of the business being protected and the employee’s interest of being able to accept employment in her desired field of work. In other words, the court will only limit an ex-employee’s ability to regain employment in the same field, which is normally what the employee has experience and is knowledgeable in, to the extent legitimately necessary to protect their previous employer.

The basic requirement of reasonableness for an enforceable non-compete provision is determined in Pennsylvania by a three-part test:

1. Whether the provision is necessary to protect the business’s legitimate interests
2. Whether it causes undue hardship on the employee
3. Whether it impairs the public interest.

Thus in many states, including Pennsylvania, whether a particular provision is reasonable is determined by whether it is limited in both time and geographical area and is reasonably necessary to protect a legitimate business interest of the employer.² In reviewing whether a provisions restriction on time, geographical area, and claim of necessity in protecting a legitimate business interest of the employer is reasonable, the court will look at the individual aspects of the particular business seeking protection.

The reasonableness of a particular provision’s duration depends upon the nature of the business interest being protected. Accordingly, a five-year restriction on an ex-employee’s ability to compete may be reasonable for one business, while a one-year restriction may be unreasonable for another business. Similarly, the reasonableness of a geographical restriction turns upon the particular protection needed in a given business. The general rule is that geographical limitations should be no broader than the area in which the employee is active, even where the employer’s business spans a broader region.³ Therefore, these provisions should be limited to the employee’s “active area.” In general, the above provisions are also only enforceable to the extent necessary to protect an employer’s legitimate business interest. Such interest, however, can be broadly defined and include customer goodwill, trade secrets, goodwill of a business sold, the loss of unique abilities of an employee, and an employee’s specialized training and skills.⁴

The non-competition provision is probably the most fundamental and common provision in an employment agreement designed to protect the interests of the employer. As long as the provision is drafted within the bounds of what is reasonably necessary for the protection of the company, the business entrepreneur can achieve comfort and security that her business will not be unduly threatened by former employee competition.

The Non-Solicitation Provision
A non-solicitation provision typically prohibits an ex-employee from soliciting customers of the employer. Depending upon the way the non-solicitation provision is drafted, it can also prohibit employees from soliciting other employees to leave and join a new organization.⁵ For example, if your company sells cell phone plans, you may require that new employees sign a non-solicitation provision to protect against them leaving and soliciting your customer contacts to start a new business.

Restrictions
There are two main restrictions generally on the non-solicitation provision. The first is generally that although bound by a solicitation provision, the ex-employee is allowed to accept customers who independently seek out the ex-employee’s services without any solicitation on the part of the ex-employee.⁶ This is because the term “solicitation” has generally been found to be defined as initiating any contact with customers of the employer.⁷ Therefore absent the ex-employer seeking out, or initiating contact with customers, the ex-employee is free from the restraints of the non-solicitation provision. The second major restriction on non-solicitation agreements is where the court will refuse to uphold the restriction because it is unreasonable. Determining whether a non-solicitation provision is reasonable will hinge upon the same factors and individual analysis as outlined above for reviewing non-compete provisions.

As long as the drafter of the employment agreement is mindful of these restrictions, a non-solicitation agreement can offer the vital protection an entrepreneur needs in securing her business against the solicitation of customers and employees.

Confidentiality Agreements
Confidentiality agreements (also known as non-disclosure agreements) are another source of protection for entrepreneurs, achieved through an employment agreement. Generally, the confidentiality agreement is used to prohibit the employee from using or disclosing confidential, customer, or trade secret information, records or property that belonged to the employer, other than for the employer’s benefit. These provisions can and should be specially tailored to the individual needs of a particular business. For example, the confidentiality provision may also require that the employee return all property to the employer upon termination or leave. It is advisable for companies to have employees execute non-disclosure agreements at the time of the commencement of employment so that confidential information is adequately protected. Some material terms in a non-disclosure agreement include the following:

• Employee “shall not disclose the confidential information to any third party”
• Non-disclosure requirement applies during employment and upon “termination of employment for any reason whatsoever”
• Non-disclosure requirement is “perpetual”
• Pennsylvania law governs the non-disclosure agreement

Please note that unlike non-compete and non-solicitation agreements, a non-disclosure agreement may indeed be perpetual. This is premised upon the fact that the law goes to great lengths to protect unique and confidential business methodologies. Moreover, it is important to note that even in the absence of a non-disclosure agreement, Pennsylvania law independently protects an employer’s trade secrets. (See Topic 10- Protecting Intellectual Capital).

Restrictions
It should also be noted that confidentiality agreements are not limited by the reasonableness requirements that govern the non-compete provision and non-solicitation provision above.⁸ They are limited, however, by what is considered confidential for a particular business. Therefore, an entrepreneur should map out, with competent legal counsel, what exactly needs to be protected prior to the drafting of such provisions. With a properly drafted confidentiality provision in place, an entrepreneur should be able to safeguard her business’s sensitive information from the employees who have access to it.

Conclusion
The above provisions are of vital importance for a business in safeguarding and protecting its interests against the employees who work there. As long as the drafter of these provisions is mindful of the particular interests of the business and of the legal restrictions applicable to each provision, the business entity should be able to achieve sufficient protection in this area. Utilizing the above discussion on the effectiveness and restrictions applicable to each provision, the business entrepreneur should be able to map out a protective plan applicable to her business and achieve that protection with the assistance of legal counsel.

¹ SHV Coal, Inc. v. Continental Grain Co., 376 Pa. Super. 241 (1988) (Noting that the employee has a common law fiduciary duty not to compete with the employer during employment).

² All-Pak, Inc. v. Johnston, 694 A.2d 347, 350 (Pa. Super. 1997).

³ American Software, USA, Inc. v. Moore, 448 S.E. 2d 206 (Ga. 1994).

⁴ Thermo-Guard, Inc. v. Cochran, 596 A.2d 188, 193-94 (Pa. Super. 1991).

⁵ Harry Blackwood, Inc. v. Caputo, 290 Pa. Super. 140 (1981).

⁶ Harry Blackwood, Inc. v. Caputo, 290 Pa. Super. 140 (1981).

⁷ Bell Fuel Corp. v. Cattolico, 375 Pa. Super. 238 (1988).

⁸ Bell Fuel Corp. v. Cattolico, 375 Pa. Super. 238 (1988).

Topic 6: Severance Agreements ›