Rules on Restrictive Covenants in Employment Relationship

Rules on Restrictive Covenants in Employment Relationship

Employers may stipulate with employee in the contract that the latter shall not get employed with a competitor or put up similar competing business.

In this instance, the Supreme Court, in the case of Solid Bank vs. Rivera (G.R. No. 163269, April 19, 2006) the employer is burdened to establish that a restrictive covenant barring an employee from accepting a competitive employment after retirement or resignation is not an unreasonable or oppressive, or in undue or unreasonable restraint of trade. Failure to do so, the covenant shall be unenforceable for being repugnant to public policy.

As the Court stated in Ferrazzini v. Gsell, cases involving contracts in restraint of trade are to be judged according to their circumstances. There are two principal grounds on which the doctrine is founded that a contract in restraint of trade is void as against public policy. One is, the injury to the public by being deprived of the restricted party’s industry; and the other is, the injury to the party himself by being precluded from pursuing his occupation, and thus being prevented from supporting himself and his family.

In Gibbs vs. Consolidated Gas Co. of Baltimore the court stated the rule that public welfare is first considered, and if it be not involved, and the restraint upon one party is not greater than protection to the other party requires, the contract may be sustained. The question is, whether, under the particular circumstances of the case and the nature of the particular contract involved in it, the contract is, or is not, unreasonable.

In cases where an employee assails a contract containing a provision prohibiting him or her from accepting competitive employment as against public policy, the employer has to adduce evidence to prove that the restriction is reasonable and not greater than necessary to protect the employer’s legitimate business interests. The restraint may not be unduly harsh or oppressive in curtailing the employee’s legitimate efforts to earn a livelihood and must be reasonable in light of sound public policy.

According to the SC, Courts should carefully scrutinize all contracts limiting a man’s natural right to follow any trade or profession anywhere he pleases and in any lawful manner. But it is just as important to protect the enjoyment of an establishment in trade or profession, which its employer has built up by his own honest application to every day duty and the faithful performance of the tasks which every day imposes upon the ordinary man.

What one creates by his own labor is his. Public policy does not intend that another than the producer shall reap the fruits of labor; rather, it gives to him who labors the right by every legitimate means to protect the fruits of his labor and secure the enjoyment of them to himself. Freedom to contract must not be unreasonably abridged. Neither must the right to protect by reasonable restrictions that which a man by industry, skill and good judgment has built up, be denied.

The SC reiterates that the determination of reasonableness is made on the particular facts and circumstances of each case. Citing Esmerson Electric Co. v. Rogers, the SC held that the question of reasonableness of a restraint requires a thorough consideration of surrounding circumstances, including the subject matter of the contract, the purpose to be served, the determination of the parties, the extent of the restraint and the specialization of the business of the employer.

It should be considered whether its enforcement will be injurious to the public or cause undue hardships to the employee, and whether the restraint imposed is greater than necessary to protect the employer. Thus, the court must have before it evidence relating to the legitimate interests of the employer which might be protected in terms of time, space and the types of activity proscribed.

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Consideration must be given to the employee’s right to earn a living and to his ability to determine with certainty the area within which his employment ban is restituted. A provision on territorial limitation is necessary to guide an employee of what constitutes as violation of a restrictive covenant and whether the geographic scope is co-extensive with that in which the employer is doing business. In considering a territorial restriction, the facts and circumstances surrounding the case must be considered.

Thus, as the SC concluded in the Solida Bank case, in determining whether the contract is reasonable or not, the trial court should consider the following factors: (a) whether the covenant protects a legitimate business interest of the employer; (b) whether the covenant creates an undue burden on the employee; (c) whether the covenant is injurious to the public welfare; (d) whether the time and territorial limitations contained in the covenant are reasonable; and (e) whether the restraint is reasonable from the standpoint of public policy.

Not to be ignored is the fact that the banking business is so impressed with public interest where the trust and interest of the public in general is of paramount importance such that the appropriate standard of diligence must be very high, if not the highest degree of diligence.

According to SC, there is distinction between restrictive covenants barring an employee to accept a post-employment competitive employment or restraint on trade in employment contracts and restraints on post-retirement competitive employment in pension and retirement plans either incorporated in employment contracts or in collective bargaining agreements between the employer and the union of employees, or separate from said contracts or collective bargaining agreements which provide that an employee who accepts post retirement competitive employment will forfeit retirement and other benefits or will be obliged to restitute the same to the employer. The strong weight of authority is that forfeitures for engaging in subsequent competitive employment included in pension and retirement plans are valid even though unrestricted in time or geography.

The raison d’etre is explained by the United States Circuit Court of Appeals in Rochester Corporation v. W.L. Rochester, Jr. that there is a clear and obvious distinction between restraints on competitive employment in employment contracts and in pension plans. The strong weight of authority holds that forfeitures for engaging in subsequent competitive employment, included in pension retirement plans, are valid, even though unrestricted in time or geography. The reasoning behind this conclusion is that the forfeiture, unlike the restraint included in the employment contract, is not a prohibition on the employee’s engaging in competitive work but is merely a denial of the right to participate in the retirement plan if he does so engage.

A leading case on this point per SC is Van Pelt v. Berefco, Inc., where, in passing on a forfeiture provision similar to the Solid Bank case, held that a restriction in the contract which does not preclude the employee from engaging in competitive activity, but simply provides for the loss of rights or privileges if he does so is not in restraint of trade.

A post-retirement competitive employment restriction is designed to protect the employer against competition by former employees who may retire and obtain retirement or pension benefits and, at the same time, engage in competitive employment.

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