Tuesday, August 26, 2014

Non-Compete Agreements: When Can They Be Enforced Against Advisors?

Brian J. Sommer
Although departing financial advisors who comply with the Protocol for Broker Recruiting (the "Protocol") are, generally speaking, free to solicit customers that they serviced at their former firms after they join their new firms regardless of any non-compete agreement they may have signed with their former employer, rightly or wrongly they may nevertheless find themselves having to defend a lawsuit alleging that they have breached any such agreement if there is any question regarding the departing advisor soliciting customers to move their accounts before he or she has left their former firm.

Under such circumstances, the departing advisor is left with no real option but to defend the claim because the alternative, whether by choice or by court order, will require the advisor to not contact or service their clients. Fortunately, and aside from any factual arguments over whether or not there is a breach of the Protocol, there are circumstances under which a non-compete can be determined to be unenforceable.

First, a non-compete is unenforceable if it lacks adequate consideration. Consideration is something of value given by both parties to a contract that induces them to enter into the agreement to exchange mutual performances. While generally speaking courts do not examine the adequacy of the consideration when determining the validity of a contract, non-competes are the exceptions to that rule. If the consideration is not adequate then the non-compete will not be enforced. Examples of adequate consideration include a new job, additional benefits, a bonus, a raise, and/or a promotion. Recently, the Pennsylvania Superior Court affirmed this rule and further held a mere recital in a non-compete agreement that the parties intend to be legally bound to the terms is insufficient consideration. Consequently, any non-compete agreement containing such language and nothing more is unenforceable. See Socko v. Mid-Atlantic Systems, 2014 Pa. Super. LEXIS 702 (Pa. Super. 2014). Interestingly, Socko refutes a decision by a Pennsylvania federal court that held the opposite in a case involving a financial advisor and a non-compete with their former employer. See Latuszewski v. Valic Financial Advisors, 2007 WL 4462739 (W.D. Pa. 2007).

Second, and even if the court finds there is adequate consideration, it may nevertheless decline to enforce the non-compete if it finds the burdens placed upon the departing advisor are too great and burdensome. For example, courts have more recently begun to consider the employee's specific circumstances and in particular the negative impact enforcing the non-compete will have on them. Thus, courts may be less inclined to enforce a non-compete on a highly specialized 60 year-old who is unlikely to start anew in another industry, or on employees who are the sole means of income for their family. See Shepherd v. Pittsburgh Glass Works, LLC, 25 A.3d 1233 (Pa. Super. 2011).

While Socko and Shepherd are the law of Pennsylvania, many non-compete agreements have clauses requiring interpretation and enforcement pursuant to another state's laws. While parties are free to choose what law is to be applied, there is nevertheless a question as to whether or not an agreement otherwise unenforceable under Pennsylvania law will still be enforced due to the governing law of the chosen state. Under such circumstances, Pennsylvania courts will enforce a choice of law provision unless (a) the chosen state has no substantial relationship to the parties or transactions and there is no reasonable basis for the parties' choice, or (b) application of the law of the chosen state would be contrary to a fundamental policy of Pennsylvania which has a materially greater interest than the chosen state in the determination of the particular issue and which would be the state of the applicable law in the absence of an effective choice of law by the parties. See Miller v. Allstate Ins., 763 A.2d 401, 403 (Pa. Super. 2000).

Prior to Socko, Pennsylvania courts enforced non-compete agreements that under Pennsylvania law lacked adequate consideration, but did not under the governing law of the chosen state, reasoning that the existence of consideration did not result in an application contrary to a fundamental Pennsylvania policy. cfn. Perma-Liner v. US Sewer & Drain, 630 F.Supp.2d 516, 522-523 (E.D. Pa. 2008). However, Socko's emphasis that, unlike other contracts, the adequacy of consideration is critically important to enforcing a non-compete agreement suggests that adequate consideration for non-compete agreements is indeed a fundamental Pennsylvania policy. Consequently, pre-Socko decisions enforcing non-compete agreements that lacked consideration merely on the basis of another's states laws as chosen by the parties may no longer be good law. Similarly, Shepherd's holding may also rise to the level of fundamental policy thereby requiring the application of Pennsylvania law notwithstanding a choice of law clause involving the application of another state's laws.

For all these reasons it is important for advisors to consult with counsel before changing firms in order to, among other things, prepare for any lawsuit over existing non-compete agreements.

This material is for informational purposes only.  It is not and should not be solely relied on as legal advice in dealing with any specific situation.

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