To be valid and enforceable, an employment agreement with a restrictive covenant must be agreed to by the employee in exchange for something valuable – “consideration.” When the restriction is first imposed at the commencement of employment, consideration is not a problem, because the employee receives a clear and obvious benefit: the job.
However, employers often come to the realization after hiring that certain employees should have executed an employment agreement with a restrictive covenant at the commencement of their employment, but did not. Other times, employers realize a current agreement needs updating. To accomplish this, employers often want to ask employees to sign “mid-term contracts” during their terms of employment. The question then arises as to whether continued employment is sufficient consideration for a mid-term contract. If it is not, what is?
In many jurisdictions, the employer’s agreement to continue at-will employment can be sufficient consideration. The reasoning applied varies, however. In some cases, courts have relied on the fact that the employee would have been terminated if he had not signed the restrictive covenant agreement. In other cases, courts have found adequate consideration only where the employment continued for a substantial period of time. Whether that period is sufficient is determined by the courts, although employment of a year following execution of the new agreement seems to be a minimum. If the employee leaves, or is terminated before then, courts have deemed there to have been no consideration.
Some courts refuse to enforce mid-term restrictive covenants absent a grant of a new or enhanced benefit to the employee, in addition to continued employment. In many states, courts require as a second precondition for enforceability that the restrictive covenant agreement must be ancillary or incidental to the employment contract, meaning that it must be subordinate to the contract’s main purpose, in addition to meeting the consideration requirement.
New consideration must be more than “illusory.” For example, in those jurisdictions requiring new consideration, where an employee has a pre-existing employment contract for a definite term, continued employment may not be sufficient because the employee had a prior, existing right to be employed such that his continued employment did not afford him any benefit to which he was not already entitled. Promotions or salary increases given prior to the signing of the restrictive covenant, rather than in exchange for signing, are also insufficient. By contrast, substantial benefits, such as promotions or a salary increase, special training, participation in a stock option plan or an annuity contract, granted contemporaneously with, or in exchange for, executing the mid-term contract, have been recognized as sufficient consideration. The applicable state law and the rulings by courts where the dispute is likely to be heard should be consulted to determine the minimum acceptable consideration.
Given there is little consistency between courts on these enforcement issues, the employer is left in a quandary. To relieve that uncertainty employers desiring to execute mid-term contracts may contemplate the security of offering separate new consideration in exchange for the employee’s execution of a mid-term contract as a matter of course, but it might not be necessary. If the mid-term agreement is replacing an existing one, language should be included in the new agreement that preserves any employer protections in the new agreement in the event the new agreement is found to be unenforceable. Given the state specific consideration requirements and importance that sufficient consideration plays in enforcement of these agreements , the advice of counsel who knows about and has experience concerning the requirements of the various state statutes and common law is critical.