Supreme Court Addreses
Assignability of Non-Competes
by Steven E. Grubb, Esquire

The recent Pennsylvania Supreme Court decision in Hess v. Gephart & Co., Inc. Pa. Supreme Court, Docket 104 MAP 2001, (Decided October 16, 2002) will most likely require employers and employees to re-examine their employment relationship where there has been a transfer of assets between companies and where those assets include employment contracts which contain restrictive covenants.

A large number of employers today use restrictive covenants, which might include covenants not to solicit customers and covenants not to compete after a termination of employment. As the Pennsylvania Supreme Court noted in Hess, the goal of these covenants is to prevent employees and agents from learning an employer's trade secrets, befriending their customers and then moving into competition with their former employer. In this day where mergers and acquisitions between corporate entities are increasingly prevalent, issues have emerged surrounding the sustainability of restrictive covenants where there has been a merger or acquisition.

One of the more common transaction types is the asset transfer. In its simplest form, this would mean Company A sells its assets to Company B, although Company A and Company B maintain their corporate forms both before and after the transaction. In other words, the owner of a company's assets (machinery, goods, property, employees) changes.

Employment contracts may also be an asset that is transferred in an asset sale. In this case, an employee's employer, at least in name, changes.

Hess addressed the impact an asset sale would have on restrictive covenants. In that case, an employee had worked for a company which subsequently sold the assets of a portion of its business to another company, including Hess' employment contract. Hess' position was then eliminated and no suitable position was found for him. He then went to work for a competitor. This activity was contrary to the non-competition provision contained in his employment contract. In a case of first impression for the Pennsylvania Supreme Court, the Court held:
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 a sale of assets. In reaching this conclusion, we find that personal characteristics of the employment contract permeate the entire transaction. Like the contract for hire, upon which the covenant was given, the employee's restrictive covenant is confined to the employer with whom the agreement was made, absent specific provisions for assignability.

Hess' covenant not to compete did not transfer from one employer to the next, and Hess was permitted to work wherever he saw fit. (This holding confirmed the analysis by Pennsylvania's intermediate appellate court, the Superior Court, in All-Pak v. Johnston).

Some of the potential ramifications of this holding are as follows:

FOR THE EMPLOYER
Employers who have acceded to their employer status by reason of an asset purchase, whereby they essentially inherit a workforce, may wish to look at the employment agreements presently in place to see whether assignment of the agreement is permitted under each employment contract. Absent a provision in the employment contract, where the employee permits assignment of his or her contract, the new owner or employer must now recognize that they may not be able to enforce these employment contracts and may want to consider signing a new contract with the employee. This might create a whole new series of problems for employers such as whether additional consideration will need to be included in the new contract or employees might refuse to sign a new contract which contains a restrictive covenant.

For those companies considering the purchase of another company's assets, those company's will have to closely review and analyze all employment contracts that are part of the sale to assure that the restrictive covenants will continue to exist after the asset transfer. A company would obviously wish to avoid the situation where it pays for employment contracts with restrictive covenants, only to learn, at a later time, that they are unenforceable. Companies now must also be should also pay closer attention to the issue of assignability in their future employment contracts.

FOR THE EMPLOYEE
Hess gives the employee, whose employer changed as a result of an asset sale, the ability to contest the validity of the subject restrictive covenant. Employees must review their contracts closely to assure that they have not agreed that their contracts can be assigned by the Employer without his or her consent.

OTHER CONSIDERATIONS
There is nothing in Hess to suggest that where the stock of a corporation is sold from one party to another, there would be an affect on a restrictive covenant. In a stock sale, the employer technically remains the same, although the owners, or shareholders, of the company change. In this situation, since there is no technical change in employer, there is no change in the employment contract.

Hess, however, may have some application to this type of transaction. One of the reasons, if not the primary reason, for the Court's decision in Hess was the personal relationship between the employer and the employee.

The Court specifically held that a covenant not to compete is:
personal to the performance of both the employer and the employee, the touchstone of which is the trust that each has in the other. 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 restraint on his employment for the benefit of a stranger to the original undertaking.

Even in a stock sale, if there are wholesale changes in an employee's work environment, such that one's employer, for all practical purposes, has changed, (i.e. wholesale change in employer, change in compensation, hours, supervisors, benefits, corporate structure, etc.) would the destruction of this personal relationship, regardless of the method of transaction, serve to void the restrictive covenant? Hess may leave this possibility open for another day.