ERISA Severance Plans and Non-Compete Agreements Must Work Together

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[author: Peter Land]

In an ever-more competitive business climate, employers are increasingly interested in protecting revenue streams through enforceable non-compete restrictions on employees. A recent federal district court decision highlights, however, that employers should take care before trying to impose new non-compete restrictions upon departing employees who are entitled to benefits under any formal severance plan.

In Pactiv Corporation v. Rupert, a management employee was terminated after a merger and offered severance pay pursuant to an ERISA-covered severance plan that applied to people terminated after the merger. To receive the benefits, the severance plan also required execution of a release agreement without specifying the form of that release agreement. When the employer required a release agreement that included a non-compete restrictive covenant that was not previously a condition of the manager’s employment, the employee refused to sign and was not paid severance benefits. After termination, the manager sued for severance pay under the plan, arguing that adding the non-compete restriction without notice of such a condition in the plan itself violated ERISA. The Northern District of Illinois agreed, holding that the non-compete limitation was a matter of substance, not just form, and that the plan had insufficiently placed the employee on notice of such a substantive requirement. Accordingly, the employee was awarded severance benefits despite his refusal to sign any release.

This decision should only apply to situations in which employers seek to impose new non-compete restrictions upon employees as a condition for their right to receive benefits under a formal severance plan. To allow flexibility for such restrictions in those circumstances, employers should either (1) ensure that all such plans expressly state that employees will not be eligible for benefits unless they sign a separation/release agreement that includes a non-compete limitation or (2) offer additional payment or other consideration beyond benefits due under an existing plan in exchange for the non-compete.

Employers are also encouraged to execute non-compete agreements with employees who take sensitive positions at the outset of the employment relationship. Having such restrictions in place prior to an employee’s separation would help avoid any conflict with formal severance plans in the first place.