Misclassifying an employee may void a non-compete agreement

In an unpublished opinion, the Third Circuit Court of Appeals denied a Pennsylvania company’s attempt to enjoin a former employee, who had entered into several restrictive covenants with the company, to compete directly against the company and solicit its customers.

What did this employer do wrong and how can you learn from its mistakes?

After the jump…

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The case is Figueroa v. Precision Surgical, Inc. In October, 2003, Precision employed Figueroa as a sales representative. Six months later, the two sides signed an Independent Contractor Agreement (“ICA”). The ICA contained a number of restrictive covenants, including a non-solicitation covenant, a non-competition covenant, and a confidentiality covenant, all of which extended for a 24-month period beyond the termination of the ICA.

Although the parties apparently intended to form an independent contractor relationship, the reality was quite different. For example, during the course of his relationship with Precision, Figueroa worked from his home while also maintaining an office at Precision. Figueroa had to report to Precision every day, attend Precision meetings, log absences, keep his schedule on a corporate electronic calendar, adhere to the Precision dress code, and check with Precision before giving quotes to companies outside his territory.

After a dispute arose in 2010, Precision ended the ICA. Figueroa then went to court to obtain a ruling that the post-employment restrictions were unenforceable. Precision counterclaimed and sought injunctive relief to prevent Figueroa from competing with the company. The lower court denied Precision’s injunction effort and the company appealed. The Third Circuit also denied the injunction request.

Be careful of unclean hands!

So what went wrong here for Precision?

First, it could not demonstrate that it would likely succeed on the merits because if seemingly failed to abide by the terms of the ICA. Namely, by exercising the level of control it did over Figueroa, it effectively treated him as an employee, rather than an independent contractor, and breached its own agreement:

Figueroa’s title was “Account Executive.” Precision established primary and secondary levels of reporting authority, as well as dress requirements, training obligations, and sales goals. Figueroa testified that he “wasn’t allowed to” solicit clients independent of Precision’s involvement, and that “[i]f I had a relationship or even talked to someone, they were all over me.” Figueroa was given what “looks almost like an employment identification picture,” a Precision business card, and a Precision headquarters telephone number. He was required to devote 100% of his time to Precision, and he was apparently required to inform Precision of future market opportunities, such as those cultivated in Puerto Rico. All of these factors make it look much more likely that Figueroa was treated as an employee in derogation of Precision’s agreement in the ICA to retain Figueroa as an independent contractor.

The Third Circuit further noted that the two sides had entered into the ICA many months after Figueroa had begun work for the company. In Pennsylvania, continued employment is insufficient consideration to support a restrictive covenant that is not entered into when work commences. Therefore, the company must provide some additional consideration (a raise, bonus, promotion, etc.). The Third Circuit found that to be lacking.

Two lessons for PA companies.

  1. Treat independent contractors like independent contractors (and employees like employees). Otherwise, you may end up with an unenforceable restrictive covenant (and a host of potential wage and hour issues).
  2. Restrictive covenants should not be afterthoughts. If a company wants its employee/independent contractor not to compete after the relationship ends, enter into a restrictive covenant when the business relationship begins. Otherwise, make sure to fork over some significant cash if you have an employee/independent contractor sign a non-competition/solicitation agreement after-the-fact.
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