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Non-Compete Agreements After An Acquisition: Are They Enforceable?

Many companies view their key executives and sales people as assets to be preserved and maintained, recognizing that these individuals add value to the organization. In an attempt to keep those assets out of the hands of competitors, companies often turn to non-compete agreements. When companies are acquired, however, a question arises as to whether or not the acquiring company will be able to benefit from these covenants not to compete. This question recently arose in the ease of Siemens Medical Solutions Health Services Corp. v. Brian J. Carmelengo, U.S.D.C., ED. of Pa., C.A. 01-816. As with many legal issues, the answer is: it depends.

Non-Compete Unaffected if Company Maintains Existence

If the acquisition is a stock purchase and the acquired company (we’ll call it Company B) maintains a separate existence, the non-compete is unaffected. Company B will still be around to enforce the Agreement. The answer is less clear, however, when Company B is merged into Company A or where the acquisition takes the form of an asset purchase.

Under Pennsylvania law, non-compete clauses in employment agreements are not assignable to successor employers unless there is either (1) an explicit assignability provision contained in the agreement, or (2) evidence that the employee consented to the assignment. In All-Pak, Inc. v. Johnston, 694 A.2d 347, 351-52 (Pa. Super. 1997) the Court explained:

Restrictive Covenants Not Assignable

Strong policy reasons 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.

These policy considerations raise substantial doubt about the enforceability of a non-compete clause when Company B “disappears” as a result of a merger. One Pennsylvania trial court has ruled that, given the considerations expressed in All-Pak, it is immaterial whether the successor corporation has acquired the former employer through a stock purchase. The Court said:

The point of focus should not be on the relationship between the old employer and the new employer, but rather as between the employee and the new employer. The strong policy considerations referred to in All-Pak recognize that the employment relationship is a personal matter between an employee and the company who hired him and for whom he chose to work. Unless an employee explicitly agreed to an assignability provision, an employer may not treat him as some chattel to be conveyed, like a filing cabinet, to a successor firm.

Joyner Sports Medicine Institute, Inc. v. Stejbach, 45 Pa. D. & C. 4th 242, 249 (Dauphin Cty. 1999).

As of this date, the Pennsylvania Supreme Court has not had the opportunity to decide if a change in control as a result of the acquisition of the majority or even 100% of the stock affects non-compete agreements.

Non-Compete May Enforceable Depending on Terms of Acquisition

The Joyner case suggests that whether or not the non-compete continues in effect after a stock acquisition would depend upon how the changes in management of the acquired company affected the employees under the noncompete. In Joyner, the Court noted that all employees were summoned to conferences where the new owners presented a new benefits package which represented a substantial reduction of benefits from the old benefit package, a new employee handbook was distributed which employees were obligated to acknowledge, paychecks were issued by the acquiring corporation and the acquiring corporation was listed as the employer on the W2 forms.

Thus, in the view of the Joyner Court, the stock acquisition effectively terminated the plaintiff’s employment with his old employer. However, because the acquisition involved a stock transaction in which the old employer continued to have a separate corporate existence, albeit as a shell corporation, the old employer was able to enforce the non-competes. Importantly, however, the non-compete was deemed to begin to run from the date of the acquisition, even if the employee remained employed by the new employer.

For example, if an employee had signed a two-year non-compete agreement, and stayed with the new employer for two years after the acquisition, he or she would be free of any restrictions from that point forward.

How Companies Can Minimize the Uncertainty

Companies can minimize the uncertainty in this area by taking certain steps. First, companies can include terms in their non-compete agreements that expressly permit assignment. Alternatively, acquiring companies can obtain an assignment of the employment contracts to which the employees expressly agree. Short of that, given the strong public policy against non-compete agreements, the usual changes and employee relationships following an acquisition may be found to be sufficient evidence that the non-compete terminated with the acquisition.

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