Fall 2003-02 Non competition clause annulled

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Number 53
Fall 2003

Non competition clause annulled

A contract clause that prohibits that a former employee compete with his ex-employer is null, as was determined in Arthur Young & Company v. Vega III, 136 D.P.R. 157 (1994).

The clause

Upon commencing to work with Arthur Young & Company, a young Virgilio Vega III (no admitted relationship with William Gates III) signed a contract that contained a non competition clause. The same stated that for two years after Vega ceased in his employment, he could not solicit nor provide services of the type provided by his employer, either to: (1) those who were clients of the firm during the year preceding termination of his employment, or (2) clients to whom Vega provided services as an employee of the firm during the five years preceding the termination.

When Vega resigned to his employment, he received a call from one Jorge Souss, then Managing Partner of the law firm of Brown, Newsom & Cordova, an Arthur Young client whom Vega had audited. Souss indicated that the law firm had decided to change auditors and desired to consider him as one of its alternatives. Vega presented a proposal, which was selected. Arthur Young sued Vega and requested the court to prohibit him from rendering services to "old Brown." The company also asked for financial damages resulting from breach of contract.

Legal principles

The trial court expressed the following legal principles as those applicable to non competition contracts:

Non competition contracts are valid only if they are reasonable.

Their reasonableness is determined on a case-by-case basis, depending on the circumstances of each.

Restrictions to competition may not be greater than necessary to protect a legitimate interest of the employer.

Restrictions to competition may not be excessively oppressive to the employee.

Neither may the restrictions be prejudicial to the general public.

The obligation to prove reasonableness rests with the party who claims it.

The court also recognized the doctrine that is known as "adhesion contracts." These are those signed by an economically stronger party who takes advantage to impose clauses advantageous to itself. Although adhesion contracts are valid, any obscure clause is to be construed in favor of the weaker party.

Vega's contract

The trial court first determined that the contract between mighty Arthur Young and 70-pounder Vega was one of adhesion. "In this case there is a powerful employer that prepares a contract that includes a non competition clause, which is signed by its employee that has no option at the time of stamping his signature." Regarding a later amendment to the contract, the judge concluded: "In our case the defendant had his liberty to contract severely curtailed, since he faced the dilemma of signing the contract that was presented to him, or refuse to do so and decline the promotion offered to him and possibly risk his employment with the company."

The trial court found unreasonable that the clause in Vega's contract lacked a geographic limitation. It likewise qualified the fact that Vega was prevented from rendering any service offered by the company to its clients, even if provided by other persons, and not by Vega. The clause also adversely affected the general public, the court continued, since it pretended that Vega abstain from rendering his professional services even when the client itself requested them, without any solicitation on Vega's part.

In light of its unreasonable breadth, the trial court declared the non competition clause to be null, and dismissed the complaint.

Appeal

Unhappy with the happy ending, Arthur Young appealed to the Supreme Court, who confirmed, although for a different reason.

First the Supreme Court found that the non competition clause was neither obscure nor ambiguous. Therefore, whether or not the contract was one of adhesion was immaterial, for only obscure clauses of an adhesion contract should be interpreted in favor of the weaker party.

Validity requirements

According to the Supreme Court, in order for a provision not to compete to be valid, it must comply with a number of requirements enumerated in the opinion, to wit:

The employer must have a valid interest to protect. That is to say, were it not for the protection of the clause, the employer's business would be substantially affected. Of extreme importance for this determination is what position the employee held in the company.

The object of the prohibition must be limited to activities similar to those carried out by the employer. These need not be limited to the specific functions of the employee.

The effects of the non competition clause may not exceed 12 months, as any additional time would be excessive and unnecessary to protect adequately the interests of the employer.

The contract must specify geographic limits, which may not exceed those strictly necessary to prevent real competition.

The clause may only apply to clients that the employee personally worked with during a reasonable time frame preceding his resignation, and that were still clients of the firm immediately prior to the resignation.

The employer must offer a consideration in exchange for the execution of a contract with a clause not to compete, such as a raise, additional benefits, a promotion, or even the initial offer of employment. Continuing in the job is not an acceptable consideration.

The employee must sign the contract freely and voluntarily.

The clause must be in writing.

Too long

The Supreme Court found the Vega contract to be in order with respect to prohibited activities (services rendered by Arthur Young) and affected clientele (those to whom Vega rendered services during the five years preceding his resignation, and which continued as clients at that time). Vega also received adequate consideration, and voluntarily signed the agreement.

Nevertheless the two-year non competition term was too long, particularly in a case such as this, where auditing and consulting services are provided annually, in shorter intervals, or in a continuous fashion. Thus, the Supreme Court concluded, the clause not to compete was null in its entirety.

‡‡ Note:

The fact that Vega was retained by Brown within the first year was of no consequence to the court's analysis. Once one of the requirements is not met, the whole provision is null.


© 2003 Goldman Antonetti & Cordova, LLC