New England Biz Law Update
The scenario is all too familiar. After two years of toiling in the laboratory vineyards, an emerging-growth technology company is preparing to consummate a venture capital financing, but the investors demand that managers and critical employees sign non-competition and non-solicitation covenants – without a bonus or stock option to support the covenants.
Or, after an embarrassing episode in which a renegade employee launches a competitive enterprise and poaches the customer names and profiles of the former employer, as well as the former employer’s key personnel, the outraged employer decides to compel all employees to sign non-competes.
Generally, for a restrictive covenant to be enforceable, it must be supported by consideration, can’t violate public policy, and must be reasonable as to scope and duration. These agreements also must protect legitimate employer interests in guarding confidential information or avoiding unfair competition.
When an employee signs a non-compete at the beginning of his employment, consideration (i.e., the employment itself) is presumed to exist. The problem is whether consideration exists for a non-compete signed after employment commences.
Where the employment is at-will, it would seem the mere promise of continued employment is meaningless and can’t be consideration.
Are the restrictive covenants described above enforceable under current Massachusetts case law? Can an employer legitimately restrain the mobility of its employees by imposing a regime of non-competition and non-solicitation covenants after the fact, that is, after commencement of “at-will” employment and without any new consideration?
Ignoring precedent
Recent Massachusetts holdings at the trial court level suggest that without new or separate consideration, these arrangements are entirely unenforceable. However, controlling precedent dating back to 1922 suggests a different result.
The landmark Massachusetts case interpreting the enforceability of non-competition covenants where continuing employment is the only consideration supporting the agreement is Sherman v. Pfefferkorn, 241 Mass. 468 (1922).
In Sherman, the Supreme Judicial Court upheld a non-compete the employee had signed after the commencement of initial employment. The court concluded the covenant was “not void for lack of consideration,” finding the employer’s absolute right to terminate the employee at will, and the employee’s right to depart voluntarily, were “on equal footing.” Other SJC cases in the ‘30s and ‘40s followed suit.
More recent cases, however (all at the trial court level), have ignored Sherman and its progeny, deviating from this precedent despite the fact that it has never been overruled. Beginning in 2001, every Massachusetts Superior Court opinion to have considered this issue has held that some additional consideration – beyond the mere continuation of employment – is necessary.
While these cases occasionally mention Sherman, they state an entirely different rule: that adequate consideration for a restrictive covenant only exists where there is some benefit to the employee in addition to continued employment.
This additional benefit can include stock options, increased compensation, increased authority, or a change in job title that benefits the employee.
This sea change in holdings is striking, especially because the difference in result cannot be attributed solely to distinguishable facts. It is true that some of these Superior Court cases have overtones of duress and demonstrate uneven bargaining power between employer and employee. And the enforceability of non-competes has always been infused with notions of fairness and equitable conduct, with careful attention paid to factual circumstances and the balancing of an employee’s right to mobility with an employer’s justifiable protection of its goodwill and confidential information.
Hostility toward non-competes
The majority of these cases, however, evidence nothing more than a general hostility toward non-competes. There is not even a hint of duress.
The impetus for the Superior Court’s break with precedent is IKON Office Solutions, Inc. v. Belanger, 59 F. Supp. 2d 125 (D. Mass. 1999). The IKON court acknowledged Sherman but nevertheless announced, “later decisions demonstrate that, in order for a restrictive covenant to withstand scrutiny, some additional consideration ought pass to an employee upon the execution of a post-employment agreement.”
The only cases the court cited for this novel and unsubstantiated proclamation were two cases that did not directly address the issue of continuing employment as consideration and, in fact, did not discuss consideration at all.
Virtually all of the recent cases rely on IKON, ignoring that (1) IKON has no precedential value in Massachusetts courts, and (2) the cases upon which IKON relied do not support this novel idea that some additional benefit is necessary. The Superior Court appears to be insupportably shirking its duty to apply Sherman and related precedent. Absent an appellate decision overturning Sherman, Massachusetts courts have no justification for departing from established principles.
Until the appellate courts resolve the turmoil on this question, however, how are employers to protect their legitimate business interests in protecting trade secrets and avoiding unfair competition?
Until some certainty emerges, employers should take precautions to improve their chances of being able to enforce these covenants.
Some simple measures include the following.
Provide consideration when asking existing employees to sign a non-compete. This consideration can include stock options, an increase in job responsibilities, or a cash bonus.
Insist on these covenants when there is a significant event in the employment relationship, e.g., a substantial change in job responsibilities or a promotion with a different job title.
Be as selective as possible in determining which employees need to sign restrictive covenants. Similarly, tailor agreements to specific confidentiality or competition concerns and/or specific employees.
Courts will consider all aspects of the parties’ behavior in assessing whether to enforce a non-compete, so it’s important to proceed with caution at every stage of the process.
John Hession is a partner in the Boston office of McDermott Will & Emery (www.mwe.com), and is a member of the firm’s corporate department and private equity/emerging companies practice. John represents emerging-growth companies, principally in the medical device, software, life sciences, telecommunications and electronic commerce fields, as well as angels and venture capital funds in the investment process in these sectors. He can be reached at [email protected].
Lauren M. Papenhausen is an associate in the Boston office of McDermott Will & Emery and is a member of the trial department. Prior to joining McDermott, Lauren served as a law clerk to U.S. District Court Judge Algenon L. Marbley in the Southern District of Ohio. She can be reached at [email protected].
