Non-Compete Agreement Is Not Assignable

A restrictive covenant not to compete in an employment contract is not assignable by the former employer to the buyer of the employer’s business, the Pennsylvania Supreme Court has ruled in a case of first impression, reversing the Superior Court’s decision. Justice Sandra Schultz Newman authored the majority opinion. Justice Michael Eakin filed a brief concurring and dissenting opinion, to which Justice Ronald Castille joined. In Hess v. Gebhard & Co. Inc., W. Lawrence Hess began working for Hoaster Co. Inc. as an insurance agent. The Lebanon County firm dealt primarily with insurance and real estate operations, and Hess serviced the company’s existing accounts. Hess’ employment agreement with Hoaster included his consent not to disclose proprietary information and also covenanted not to compete with Hoaster within a 25-mile radius of Lebanon, Pa., for five years after the termination of his employment. In July 1996, Charles Brooks, the owner of Hoaster, entered into an agreement with Gebhard, an insurance brokerage firm, to sell the assets from the insurance portion of his business. Brooks did not sell the real estate portion of his business to Gebhard, and continued to operate as Hoaster Inc. The conditions of sale provided that, for three years, Hoaster would receive the commissions and fees earned on the sold insurance accounts, according to the opinion. Hess’ employment agreement was also sold in the sale, including the covenant not to compete. In the agreement’s inventory of assets, Hess’ employment agreement was valued at $0, and good will was also valued at $0. Gebhard then informed Hess that it decided to eliminate his position at the end of 1996. Hess then began employment negotiations with Bowman’s Insurance Agency, an insurance firm also in Lebanon County. In early 1997, Hess’ contract with Bowman was almost finalized. Less than one week after Hess’ last day at Hoaster, Hess used information that he acquired while working at Hoaster to solicit Lebanon County, one of Hoaster’s main clients, as a new client for Bowman. Both Gebhard and Hoaster learned of Hess’ attempt to solicit Lebanon County and sent Bowman and Hess a letter about the covenant not to compete. According to the opinion, the letter also threatened legal action if Hess refused to comply with the terms of the covenant. Bowman then decided against Hess, and, according to the opinion, did so as a result of the letter. Hess then filed suit against Gebhard, who joined Hoaster as a defendant in the suit. Hess’ claims alleged intentional interference with prospective contractual relations. Hess asked the court to enjoin the defendants from contacting possible employers and to void the enforceability of the employment agreement, requested that the court void the covenant not to compete and sought monetary damages for intentional interference with prospective contractual relations. The Lebanon County trial court denied Hess’ intentional interference claims and held that the assignment of the covenant from Hoaster to Gebhard was enforceable. The trial court then determined that while assignment to Gebhard was not improper, the employment agreement was unreasonable as to time and distance and limited the duration of the covenant to Dec. 1, 1998. The court also forbade Hess to contact Hoaster and Gebhard’s insurance customers for an additional two-year period. The court also found that Hess was not entitled to damages for his alleged injuries, and the Superior Court affirmed the lower court’s decision. The Superior Court determined that Hess was bound by the covenant not to compete to protect the interests of Hoaster in the continuing profitability of the assets purchased by Gebhard. But, the supreme court disagreed. In Pennsylvania, Newman wrote for the court, restrictive covenants are enforceable if they are imperative to an employment relationship between the involved parties, if the restrictions the covenant imposes are reasonably necessary for the protection of the employer and if the restrictions imposed are reasonably limited in duration and geography. Newman also noted that, in Pennsylvania, restrictive covenants are generally not favored and have been historically viewed as a trade restraint that can negatively impact a former employee. The court then turned to the issue of first impression and addressed whether the assignment of the employment agreement to Gebhard was valid. According to the opinion, Hess argued that a restrictive covenant not to compete is not assignable by the former employer to a purchaser of the assets of the employer’s business. “This court has historically distinguished the covenant not to compete in an employment agreement from one that is contained in an agreement of sale,” Newman wrote, citing the court’s decision in Beneficial Fin. Co. of Lebanon v. Becker and March v. Allabough. The court then applied the balancing test established in 1976′s Sidco Paper Co. v. Aaron that balances the employer’s protectible business interests against the employee’s interests in earning a living and then balances the result against the interest of the public. Covenants can protect trade secrets, confidential information, good will and unique or extraordinary skill, Newman said, but, if the covenant is developed for another purpose, such as keeping an employee from competing to the advantage of the employer, the covenant is not enforceable. Hoaster and Gebhard contended that an employer has a protectible interest in the customer good will developed by its employees and that the assignment was therefore proper, but the Supreme Court disagreed with the argument. “Good will often does not survive the disassociation of those individuals from the business,” Newman wrote. “This type of good will, which is non-transferable and purely person to the owner, has little value in terms of a sale of the business.” The opinion then noted that the value placed on the good will of the business in the sale transaction between Hoaster and Gebhard was $0. Because the good will had no monetary value, the court said, it could not provide a legally protectible business interest for either Hoaster or Gebhard. The high court also said that covenants should be construed narrowly and that the fact that an individual may have confidence in the character and personality of one employer does not mean that the employee would be willing to suffer an employment restraint for the benefit of a stranger to the original agreement. “Therefore, we hold that a restrictive covenant not to compete, contained in an employment agreement, is not assignable to the purchasing business entity, in the absence of a specific assignability provision, where the covenant is included in the sale of assets,” Newman wrote. The court then turned to Hoaster and Gebhard’s assertion that if the covenant was found to be unenforceable by Gebhard, Hoaster could still enforce the agreement because Hoaster still had an interest in Gebhard’s retention of Hoaster’s former insurance clients. Hess countered that Hoaster’s remaining interest was merely an issue of profit and therefore did not stem from a protectible business interest. In siding with Hess, the court determined that Hoaster failed to demonstrate that the information it sought to protect was unique to its business and that it deserved protection as a trade secret or confidential information. “Because Hoaster cannot demonstrate that confidential information is at issue, and, because Hoaster has sold the insurance accounts and is no longer in the insurance business, Hoaster has no legally protectible interest in those insurance accounts. Without a protectible business interest, Hoaster may not enforce the covenant not to compete,” Newman said. Eakin agreed with the majority that an express provision is an appropriate prerequisite to assignability of a noncompetition agreement, but, he said, in the case at bar Hoaster’s right to enforce the covenant should remain. “How can we say he cannot protect [the expectation that Hess could not jeopardize collecting interest] by enforcing that for which he bargained for with Hess?” Eakin wrote. Even if the covenant was not assignable, Eakin said, 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,” he wrote.