Misclassification of Employee May Impact Employer’s Ability to Enforce Non-Compete Agreement

June 1, 2011
By Lauren Moak on June 1, 2011 7:49 AM |

In order to enforce a noncompete agreement, the party seeking to enforce the agreement must first show that a valid contract exists. Usually this requirement is easily satisfied, but employers not take it lightly. For instance, some employees have successfully argued that their former employer’s failure to fully compensate them prevented the employer from enforcing the non-competition agreement. This outcome is premised on the principle of contract law that ‘a material breach by one party to a contract entitles the non-breaching party to suspend performance. A recent Third Circuit opinion indicates that in some cases, an employer’s misclassification of an employee as an independent contractor may result in a breach of contract, which can similarly prevent enforcement of a non-competition agreement.

In Figueroa v. Precision Surgical, Inc., the employer had an independent contractor agreement (“ICA”) with Joseph Figueroa and a medical equipment supplier called Precision Surgical, Inc. The ICA included several restrictive covenants, including non-solicitation, confidentiality, and non-competition provisions.

Figueroa worked for Precision from 2004 through September 2010. During those years, Precision began to treat Figueroa as an employee, rather than an independent contractor. Among Precisions requirements were (1) that Figueroa devote 100% of his energy to selling products offered by Precision, (2) that he report to his supervisors daily and attend monthly meetings, (3) that he abide by a dress code, and (4) that Figueroa obtain permission from Precision before giving quotes to certain prospective customers.

As Precision’s supervision and reporting requirements became more onerous, Figueroa objected. He eventually requested a new independent contractor agreement that clarified his relationship to Precision and would eliminate the conduct to which Figueroa objected. Precision refused, instead informed Figueroa that it wanted to move its salesmen toward an employment relationship, eliminating all independent contractor positions. When Figueroa refused to become an employee, Precision terminated his independent contractor agreement.

After Precision terminated his contract, Figueroa brought a lawsuit seeking a declaratory judgment that the non-competition provisions in his independent contractor agreement were invalid. Precision brought a counterclaim seeking a preliminary injunction enforcing the non-competition provisions. Precision alleged that Figueroa was actively violating the non-compete by working as an independent sales representative for one of Precision’s direct competitors.

Figueroa alleged two breaches of the ICA: he alleged that he had been treated as an employee rather than an independent contractor, and that he had not been fully compensated according to the terms of the ICA. After briefing by the parties, the District Court denied Precision’s Motion for Preliminary Injunction on the basis that Precision had more likely than not breached the ICA. The Third Circuit affirmed.

In upholding the District Court’s ruling, the Third Circuit noted specific requirements imposed by Precision. Among them were (1) the establishment of primary and secondary levels of reporting authority, (2) dress requirements, (3) training obligations, (4) sales goals, and (5) the requirement that Figueroa devote 100% of his time to Precision. These requirements, the Third Circuit concluded, were not consistent with the title of an independent contractor. Consequently, Precision breached the ICA by treating Figueroa as an employee, instead of an independent contractor.

Most employers are aware—and all employers should be aware—that properly classifying workers as employees or independent contractors is significant for multiple reasons, including proper income tax withholding and liability under the Fair Labor Standards Act. However, employers should now consider an additional consequence for misclassifying their workers—treating an independent contractor as an employee may result in a court’s determination that the employer has breached the independent contractor agreement, rendering the restrictive covenants unenforceable. Based on the Third Circuit’s holding, employers should review independent contractor agreements to ensure that the requirements imposed on independent contractors are consistent with the terms of the agreements.

Figueroa v. Precision Surgical, Inc., No. 10-4449 (3rd Cir. April 12, 2011)