Lead Opinion
This matter arose as a result of the assignment by Eugene Hoaster Company, Inc. (Hoaster), of the employment agreement and covenant not to compete of Appellant, W. Lawrence Hess (Hess), to Gebhard & Co. (Gebhard), as part of an asset sale of an insurance agency. After thorough review, we reverse.
FACTS AND PROCEDURAL HISTORY
On April 29, 1974, Hess, a life-long resident of Lebanon County, commenced employment as an insurance agent with Hoaster. As part of his employment, Hess executed an employment agreement in which he consented not to disclose proprietary information and covenanted not to compete with Hoaster within a twenty-five mile radius of the City of Lebanon for a period of five years after the termination of his employment.
The agreement stated in pertinent part:
THE AGENT AGREES:
3. Not to disclose to any person or organization any information concerning the business of the Agency, or its affairs, secured in the course of, or incidental to the terms of this Agreement, and after its termination.
4. Upon the termination of this Agreement, not to engage in the same or similar business as that now earned on by the Agency, nor work for an individual or firm engaged in such line or similar line of business within a radius of twenty-five (25) miles of the City of Lebanon, for a period of five (5) years from the date of termination of this Agreement.
In the event that any court of competent jurisdiction determines this covenant to be unreasonable either in extent of distance or time, it shall be considered modified so as to cover the maximum extent of time and distance which such court shall find permissible under the circumstances.
Termination of this Agreement in any manner shall not invalidate the provisions respecting competition and ownership of the business.
(Reproduced Record at 24a; Agent’s Agreement at 2.) Hoaster’s business consisted primarily of insurance and real estate operations and Hess’ primary job was to service Hoaster’s existing insurance accounts, for which he received a salary plus benefits.
In July of 1996, Charles Brooks, Esq. (Brooks) entered into a sales agreement with Gebhard to sell all the assets associated with the insurance portion of his business, effective January 1,1997. Pursuant to the contract of sale, Brooks sold only the insurance portion of his business to Gebhard, while he retained the real estate operation. He continued to operate as Hoaster, Inc., under the same corporate entity. The agreement also provided that, for three years after the sale, Hoaster would receive, as part of the sale price, the commissions and fees earned on the insurance accounts transferred from Hoaster to Gebhard. The contract included the sale of all of Hoaster’s then-existing contracts and agreements, including Hess’ employment agreement containing the covenant not to compete. The inventory of assets being sold specifically included the employment agreement, expressly valued at $0.00, and goodwill, expressly valued at $0.00. (Hearing of August 27, 1999, Exhibit 11.) It is undisputed that Hess did not consent to the assignment of the covenant to Gebhard and that no one ever discussed the covenant with him or asked him to agree to its assignment.
In November of 1996, Gebhard informed Hess that it had decided to eliminate Hess’ position when Gebhard officially assumed ownership. Gebhard did tell Hess that there might be two positions available on the effective date of sale, neither of which involved the work that Hess had done for twenty-two years, although Gebhard said that he had reservations concerning Hess’ ability to perform the positions. One involved new sales only and the other was as a customer service representative, a position requiring typing skills that would be offered at a salary far less than Hess was earning. Hess did not feel that he was qualified for either position and, in December of 1996, he indicated that he was not interested. Hess worked for Hoaster until December 31, 1996, and Gebhard assumed control on January 1, 1997. Gebhard provided Hess with a letter of recommendation.
In November of 1996, unbeknownst to Hoaster and Gebhard, Hess began employment negotiations with Bowman’s Insurance Agency (Bowman’s), a competing firm in Lebanon County. In early January of 1997, Hess and Bowman’s were in final employment contract negotiations. On January 5, 1997, less than one week after leaving Hoaster, Hess used information that he had acquired while in Hoaster’s employ and solicited the County of Lebanon, one of Hoaster’s major clients, as a new client for Bowman’s. Gebhard and Hoaster learned of this and sent Hess a letter, with a copy to Bowman’s, reminding Hess of the covenant not to compete and threatening legal action if Hess refused to comply. As a result of the letter, Bowman’s decided against hiring Hess. Shortly thereafter, Hess filed suit against Gebhard, who joined Hoaster as a party defendant.
Hess filed claims in law and equity in the Court of Common Pleas of Lebanon County (trial court), alleging intentional interference with prospective contractual relations; asking the court to enjoin Hoaster and Gebhard from contacting his prospective employers; asking the court to void the enforceability of the employment agreement; requesting that the court void the covenant not to compete; and seeking monetary damages for intentional
The Superior Court affirmed, holding that the assigned covenant was enforceable because Hoaster retained a continuing interest in Hess’ competitive employment, even after the sale of its business. The Superior Court distinguished the present matter from its decision in All-Pak, Inc. v. Johnston,
The lower court held that the assignment of the insurance portion of the business did not destroy the covenant not to compete because Hoaster continued to be involved in the business. Charles Brooks, the owner of Hoaster, testified that he continued to be involved in the insurance portion now owned by Gebhard. Hoaster continued to receive compensation from Gebhard on the proceeds from Hoaster’s client base sold to Gebhard. Hess, after he gained new employment with Bowman’s Insurance Agency, contacted a client of Gebhard who was formerly a client of Hoaster and attempted to procure the client’s business. Because Gebhard’s client was a former client of Hoaster, Hoaster would lose compensation from Gebhard if the client went with Bowman’s Insurance Agency. Therefore, we find that, unlike the original employer in All-Pak, Inc., Hoaster, who was the original employer in the present covenant, had a continuing interest via Gebhard in enforcing the covenant, not to compete.
Hess v. Gebhard & Co.,
Restrictive covenants, of which non-disclosure and non-competition covenants are the most frequently utilized, are commonly relied upon by employers to shield their protective business interests. The non-disclosure covenant limits the dissemination of proprietary information by a former employee, while the non-competition covenant precludes the former employee from competing with his prior employer for a specified period of time and within a precise geographic area. In Pennsylvania, restrictive covenants are enforceable if they are incident to an employment relationship between the parties; the restrictions imposed by the covenant are reasonably necessary for the protection of the employer; and the restrictions imposed are reasonably limited in duration and geographic extent. Sidco Paper Co. v. Aaron,
Historical Perspective
As early as the fifteenth century, pursuant to English common law, restrictive covenants in the employment arena were per se void and unenforceable. Morgan’s Home Equip. (reviewing Dyer’s Case, Y.B. Mich. 2 Henry 5, f. 5, pi. 26 (C.P.1414) (striking down covenant whereby an individual bound himself to another to refrain from practicing his trade in a particular village for a brief period; the Court observed: “The obligation is void because the condition is against the common law, and by God, if the plaintiff were present he should rot in gaeol till he paid a fíne to the King.”)). Medieval concepts of apprenticeship prohibited a person from pursuing a trade in which he had not been apprenticed and that one who did so was subject to a penalty. Gary Minda, The Common Law, Labor and Antitrust, 11 Indus. Rel. L.J. 461 (1989). Thus, covenants not to compete were disfavored because prohibiting an employee from working under the supervision of one other than his original employer resulted either in his violation of the law or the deprivation of his right to earn a living.
A more equitable reasonableness inquiry eventually replaced the rule of per se invalidity in the early eighteenth century. See, e.g., Mitchell v. Reynolds, 1 P.Wms. 181, 24 Eng. Rep. 347 (Q.B.1711). In Mitchell, the court upheld an agreement whereby a baker assigned the lease of his bakeshop to Reynolds and agreed not to practice his trade as a baker in the same parish for the term of the lease. Justice Parker applied a balancing test and concluded that an individual’s right to work; the public’s right to unrestrained competition, and the right to contract must all be examined in determining whether to enforce a restrictive covenant. Id. The court held the agreement enforceable and reasoned that, while general restraints prohibiting the practice of a trade were void, partial restraints that operated within a small, defined geographic area were enforceable if the consideration was sufficient to show that the agreement was reasonable. Id. Thus, the balancing test was born; it has been applied for centuries and is still employed by courts today.
Industrialism spawned the abandonment of the medieval rules of apprenticeship and covenants were refined and appeared in
In contemporary corporate culture, covenants hav'e developed into important business tools to “allow employers to prevent their employees and agents from learning their trade secrets, befriending their customers and then moving into competition with them.” Miller Mechanical, Inc. v. Ruth,
The development of a body of law in Pennsylvania both paralleled and deviated i'rom the development of the law within other jurisdictions. A review of the case law dealing with employee non-competition agreements reveals that an overwhelming majority of jurisdictions, including Pennsylvania, require, at a minimum, that such contracts be reasonably related to the protection of a legitimate business interest. Generally, American courts insist that an employer may not enforce a post-employment restriction on a former employee simply to eliminate competition per se; the employer must establish a legitimate business interest to be protected.
Validity of Assignment
Review of the laws and decisions of our sister states that permit the assignment of employee non-competition covenants, as well as federal case law, reveals a wide disparity of treatment among the jurisdictions. More than a dozen states have rendered decisions on whether employment contracts containing covenants not to compete are assignable to the new owner in the evént of a sale of the business. The majority of these states have concluded that the restrictive covenants are not assignable. Some of these jurisdictions have based their decision on a finding that the employment contracts, and therefore the covenants, are personal to the parties and may not be assigned.
There are also several federal decisions that are not binding on this Court, but provide persuasive authority. In American Colortype Co. v. Continental Colortype Co.,
With this framework in mind, we turn to the matter before us. Hess asserts that a restrictive covenant not to compete in an employment contract is not assignable by the former employer to a purchaser of the assets of the employer’s business and that the Superior Court erred in so finding.
In equity matters, appellate review is based on a determination by the appellate court of such questions as whether: (1) sufficient evidence supports the findings of the judge; (2) the factual inferences and legal conclusions based on those findings are correct; (3) there has been an abuse of discretion or an error of law. 16 Standard Pennsylvania Practice 2d § 91:182 (1995) (footnotes omitted). Generally, in an appeal from a trial court sitting in equity, the standard of review is rigorous. Lilly v. Markvan,
Our law permits equitable enforcement of employee covenants not to compete only so far as reasonably necessary for the protection of the employer’s protectible business interests. Reading Aviation Serv. Co. v. Bertolet,
As previously indicated, this Court has historically distinguished the covenant not to compete contained in an employment agreement from one that is contained in an agreement of sale. Beneficial Fin. Co. of Lebanon v. Becker,
Fundamental, then, to any enforcement determination is the threshold assessment that there is a legitimate interest of the employer to be protected as a condition precedent to the validity of a covenant not to compete. Generally, interests that can be protected through covenants include trade secrets, confidential information, good will, and unique or extraordinary skills. Morgan’s Home Equip.,
In the instant matter, Hess contends that the assignment of the covenant was invalid because he did not consent to the assignment, relying on the Superior Court decision in All-Pak, Inc. We agree.
In All-Pak, Johnston was hired as a sales representative and entered into an employment contract that contained nondisclosure and non-competition covenants. Subsequently, an investment group called “Total-Pak, Inc.” purchased all of the assets of All-Pak, Inc., including the name. Total-Pak, Inc. then changed its name to “All-Pak.” Johnston continued working for the new “All-Pak” until his employment was terminated, when he began working for a competitor. The new “All-Pak” filed suit against Johnston seeking to enforce the covenant not to compete. After noting the dearth of precedent,
Strong [public] policy considerations underlie the conclusion that restrictive covenants are not assignable. Given that restrictive covenants have been held to impose a restraint on an employee’s right to earn a livelihood, they should be construed narrowly; and, absent an explicit assignability provision, courts should be hesitant to read one into the contract. Moreover, the employer, as drafter of the employment contract, is already in the best position to include an assignment clause within the terms of the employment contract. Similarly, a successor employer is free to negotiate new employment contracts with the employees, as the record reveals new All-Pak did with several employees, or secure the employee’s consent to have the prior employment contract remain in effect.
AU-Pak,
Hoaster and Gebhard contend that an employer has a protectible interest in the customer good will developed by its employees, relying on this Court’s decision in Boldt Mach. & Tools, Inc. v. Wallace,
This Court has defined good will as that which “represents a preexisting relationship arising from a continuous course of business.... ” Butler v. Butler,
Hoaster and Gebhard also maintain that, because Hoaster had a continuing interest in the performance of the contracts sold to Gebhard, Hoaster had a financial stake in the proceeds of the insurance contracts after Hess’ termination of employment. However, we find this argument unpersuasive in view of the Commonwealth’s policy of strict interpretation of restrictive covenants in employment contracts.
We observe that nothing in the employment agreement executed by Hess and Hoaster suggests that the parties intended or expected the restrictive covenants to be assignable. Further, this Court addressed assignability, albeit within the context of a liquor license, in Wilcox v. Regester,
We also find that we agree with Judge Schiller that covenants should be construed narrowly and that courts should hesitate “to read [an assignability provision] into the contract.” Allr-Pak,
Hess asserts that the assignment extinguished Hoaster’s interest in the employment contract and the covenant not to compete, and contends that Hoaster retains no rights to the covenant, relying on the decision of this Court in Wilcox. Hess, however, misconstrues our language in Wilcox. This Court merely stated in Wilcox that the assignment was not effective where the obligor has not assented to the assignment. There is no holding contained in Wilcox that the rights of the assignor are extinguished when the assignment is ineffective.
Hoaster and Gebhard argue in the alternative that, if the assignment is invalid and Gebhard may not enforce the covenant, then Hoaster may enforce the non-competition covenant against Hess. Hoaster and Gebhard assert that, because Hoaster continues to possess an interest in Gebhard’s retention of Hoaster’s former insurance clients, the covenant not to compete is still valid, as long as it is reasonable. Hess asserts, however, that the nature of Hoaster’s continuing interest, pivotal to the decision of the Superior Court, is merely in terms of the payout from the asset purchase. As such, Hess complains that the interest of Hoaster is too attenuated and does not stem from a recognized protectible business interest because Hoaster is no longer in the insurance business. We must agree. As we previously stated, “Our law permits equitable enforcement of employee covenants not to compete only so far as reasonably necessary for the protection of the employer.” Sidco,
Hoaster asserts a continuing interest in the insurance accounts sold to Gebhard because it retains a financial interest in the performance and continuance of the accounts as reflected in the payout provisions of the sales agreement. The Superior Court agreed, reasoning that, as long as Hoaster retained a financial interest in the performance of the covenant in such a way that it would benefit by the performance of the covenant and lose by its violation, the covenant was enforceable. The “financial interest” found sufficient to keep the covenant alive was the retention of an interest in the future profits of the business of the corporation in the hands of a successor. However, pure financial gain at the expense of restricted competition is insufficient to constitute a protectible business interest. This Court, quoting Addyston Pipe & Steel Co.,
[W]here the sole object of ... the contract ... is merely to restrain competition, and enhance or maintain prices, it would seem that there was nothing to justify or excuse the restraint, that it would necessarily have a tendency to monopoly, and therefore would be void. There is in such contracts no main lawful purpose
Jacobson,
We find no support for the right of Hoaster and Gebhard, pursuant to the assignment, to impose upon Hess the potential increase in burden of a new and expanded business venture. We are also mindful that it is the employer that drafts an employment agreement that is executed by both parties for the benefit and protection of the employer. It is a simple matter for the employer to insert an assignment clause into the agreement at the time that the agreement is drafted to cover future contingencies, such as those that occurred here. The failure of an employer to include specific provisions in an employment contract will not be judicially forgiven or corrected at the expense of the employee.
Accordingly, because enforcement is not reasonably necessary to protect the current, non-protectible business interests of Hoaster and because an assignment of a restrictive employment covenant without the consent of the assignee otherwise offends public policy, we reverse the Order of the Superior Court.
Notes
. It is noteworthy that the employment agreement was not specifically drafted for Hess or for one who worked in Hess' capacity. The agreement was designed for a producer of new business rather than a servicer of existing accounts. Thus, as a servicer, Hess received a salary rather than commissions.
. The earliest known American case involving a restrictive covenant is Pierce v. Fuller,
. See, e.g., Sisco v. Empiregas, Inc.,
. See, e.g., Trinity Transport v. Ryan,
. See, e.g., Bradford & Carson v. Montgomery Furniture Co.,
. It is also noteworthy that the federal courts in Siemens Med. Solutions Health Serv. Corp. v. Carmelengo,
. The trial court, in fact, reformed the covenant temporally and geographically. (Trial Court II.) We express no opinion on the validity of the original covenant or the alterations effected by the trial court, as these matters are not before us.
. Although this is a matter of first impression for this Court, it was presented with nearly identical fact patterns in Bauer v. P.A. Cutri Co. of Bradford,
.
Concurrence Opinion
CONCURRING AND DISSENTING OPINION
I agree that an express clause is an appropriate prerequisite to assignablility of a noncompetition agreement. However, I believe the original party’s right to enforce the covenant here remains, and hence dissent from that portion of the analysis of my colleagues.
Part of the sale price was Hoaster’s entitlement to commissions and fees on existing accounts for three years after sale. That is, Hoaster took less purchase money up front and expected to receive the rest of the sale price over the next three years. His decision to accept this arrangement was certainly with the consideration that he had a covenant with Hess preventing the latter from competing and jeopardizing those expected fees. In such a case, how can we say he cannot protect that expectation by enforcing that for which he bargained for with Hess?
I join the majority’s holding that an assignability provision is necessary for the covenant to be passed from seller to buyer. However, if it is not assignable, it is not necessarily extinguished by the sale; where the seller retains a significant tangible interest in the matters affected by the covenant, I would find the seller retains the right to enforce the covenant, if reasonable.
. My colleagues justify restricting the assignability of the covenant in part because of the personal nature of the covenant in the first place — it is between the contracting parties. This coin has two sides, however. If the covenant is truly personal to Hoaster, his ability to enforce it survives the sale.