Withholding Wages From Departing Employees May Render Non-Competes Unenforceable

money.jpgFormer employees seeking to get out of their noncompete agreements often throw up a flurry of defenses. Most of these defenses usually pertain to the scope of the restrictions, whether the covenant is designed to protect legitimate business interests, or the balance of hardships. Occasionally, however, employees are able to successfully argue that the non-compete is not an enforceable contract.

One such defense is to assert that there had been a prior material breach of the underlying contract by the former employer. If the employer materially breached the employment agreement, the employee may be excused from compliance with the covenant not to compete.

It is not all that uncommon for companies to withhold wages or bonuses from departing employees who go to work for a competitor or solicit their customers. But employers should think twice before doing this, especially if there is no legal basis for withholding the compensation.

A defense of prior material breach is often related to failure to pay wages or compensation under the employee’s employment agreement. In Dickinson Medical Group, P.A. v. Foote, a Delaware Superior Court found a medical group’s failure to pay a former employee a $4,150 bonus due under the employment contract constituted a material breach and excused her from performance under the contract’s covenant not to compete clause. 1989 Del. Super. LEXIS 156 *19-21 (Del. Super. Mar. 23, 1989).

Less obvious is what happens if the employer fails to pay wages to an employee employed on an at-will basis. The answer may depend on the underlying consideration for the noncompete agreement. If the consideration for entering into the noncompete agreement was the offer or continuation of the employee’s employment, care must be taken not to do anything that would be considered a material breach of the at-will employment contract.

Failure to pay a material portion of an employee’s wages or benefits may open the door for this defense. In addition, since every at will employment contract under Delaware law contains an implied covenant of good faith and fair dealing, companies must keep in mind that the termination of an employee, in certain limited circumstances, may constitute a breach of the employee’s at-will employment contract. The Court of Chancery has recognized in dicta that terminating an employee in violation of this implied covenant could render a covenant not to compete unenforceable. Research & Trading Corp., 1992 Del. Ch. LEXIS 234 (Del. Ch. Nov. 18, 1992) (“Plainly the circumstances in which an at will employee is terminated may have a vital bearing upon the question whether a covenant against future competition will be specifically enforced.”).

The bottom line is companies seeking to enforce noncompete agreements against departing employees must be careful not to let them off the hook by wrongfully withholding earned compensation. Even the grounds for termination in some limited situations may provide a defense to the enforcement of a covenant not to compete.

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