CONTRACTUAL RESTRAINTS ON EMPLOYEE CONDUCT Lawrence F. Carnevale

CONTRACTUAL RESTRAINTS
ON EMPLOYEE CONDUCT
©Lawrence F. Carnevale
Chairman, Litigation Department
Carter Ledyard & Milburn LLP
June 24, 2010
2 Wall Street, New York, NY 10005 212-732-3200 Fax: 212-732-3232
701 Eighth Street, NW, Washington, DC 20001 202-898-1515 Fax: 202-898-1521
Table of Contents
Introduction .........................................................................................................................................1
I.
Contract-Based Theories of Liability.......................................................................1
A.
Covenants Not-to-Compete.........................................................................1
1.
Generally.............................................................................................1
2.
Consideration .....................................................................................2
3.
The Employer’s Protectible Interest...............................................7
4.
II.
a.
Trade Secrets .........................................................................7
b.
Unique or Extraordinary Employee
Services.................................................................................10
c.
Goodwill...............................................................................12
Reasonableness of the Limitations................................................13
a.
Geographic Restrictions.....................................................14
b.
Duration ...............................................................................15
c.
Hardship Imposed on the Employee...............................16
d.
Other Factors ......................................................................16
i.
Circumstances of Termination .............................16
ii.
Change in the Former Employer’s
Status ........................................................................18
iii.
Hardship Imposed on Third
Parties.......................................................................19
5.
Judicial Modification of Unreasonable NonCompetition Covenants..................................................................19
6.
State Statutes Restricting Non-Competition
Covenants.........................................................................................23
B.
Breach of Employment Contract Duration Provision ...........................24
C.
“Garden Leave” Provisions........................................................................24
D.
Non-Solicitation Provisions .......................................................................26
E.
Non-Acceptance Provisions.......................................................................28
F.
Confidentiality Provisions...........................................................................31
G.
Intra-Competitor No Poach Agreements.................................................31
Damages ....................................................................................................................34
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Introduction
Sudden losses of valuable business, goodwill and human capital are all too common
within service-oriented industries when employees defect to join the competition. For those
pursuing opportunities to increase revenues and diversify business bases by adding key
personnel, bad planning or lack of control over the employees can lead to serious liability and
litigation. This is particularly so in industries where responsibility to develop business is
delegated to employees who naturally develop personal relationships of trust and confidence
with clients. Client loyalty transfers to the employees and the business may become as portable
as the employee.
Legal issues typically drawn into focus under these circumstances are the parties’
respective contractual rights, confidentiality obligations, the theft of proprietary information,
fiduciary obligations of employees and unfair business conduct by competitors. This paper is
designed to provide a survey of relevant case law addressing the contractual rights and liabilities
of employees and the competitors among whom they move.
I.
Contract-Based Theories of Liability
A.
Covenants Not-to-Compete
1.
Generally
Where an employee under contract voluntarily terminates his employment and moves to a
competitor before the term of the contract has expired, a covenant not-to-compete is often at the
heart of the ensuing controversy. A covenant not-to-compete is a contractual provision which,
upon termination of an employment relationship, seeks to prevent an employee from engaging in
competitive activity which would damage the employer’s business. The provision typically
prohibits the employee from working for or in association with a direct competitor of the
employer.
The emphasis of this paper is on the law of New York, although employee raiding is not
only a local phenomenon. Although there are common threads of legal analysis throughout the
nation, it is important to note that several states have statutes governing the enforceability of
non-compete covenants. See Section I.A.6 below. Therefore, it is important to determine the
statutory limitations on a non-compete covenant in addition to the general guidelines discussed
below.
Generally, covenants which unreasonably limit competition or restrict the ability of
individuals to find employment are disfavored by the courts. See, e.g., Heartland Sec. Corp. v.
Gerstenblatt, No. 99 Civ. 3694, 2000 WL 303274, *5 (S.D.N.Y. Mar. 22, 2000) (reciting the
common theme that “[r]estrictive covenants are generally disfavored by law and are only
enforced under limited circumstances. The policy underlying this strict approach rests on
notions of employee mobility and free enterprise”). The primary factors most courts consider in
analyzing the enforceability of a covenant not-to-compete are: (1) whether the covenant is
supported by consideration; (2) the scope of the prohibited activities; (3) the geographic area in
which competition is prohibited; (4) the duration of the restriction; and (5) whether the employer
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has a legitimate “protectible interest” at stake and whether the restrictions imposed are
reasonably designed to protect only those interests.
Restrictive covenants affecting a broad range of types of employment have been analyzed
and upheld under New York law and the law of other states. These run the gamut from more
prosaic trades, such as the selling of balloon bouquets, to indisputably unique services, such as
those of singer James Brown, and include both blue-collar and white-collar workers. The inquiry
and the scope of the injunctive remedy are often fine-tuned to reflect the needs of the occupation
and the industry. To name a few:
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Surgeon. Ricca v. Ouzounian, 51 A.D.3d 997, 859 N.Y.S.2d 238 (2d Dep’t 2008);
Commodities broker. Natsource LLC v. Paribello, 151 F. Supp. 2d 465 (S.D.N.Y. 2001)
and Kelly v. Evolution Markets, Inc., 626 F. Supp. 2d 364 (S.D.N.Y. 2009);
Securities broker. First Empire Securities, Inc. v. Miele, 17 Misc.3d 1108(A), 2007 WL
2894245 (N.Y. Sup. Ct. Suffolk County Aug. 10, 2007);
Financial consultant. Merrill Lynch, Pierce Fenner & Smith v. Bennert, 980 F. Supp. 73
(D. Me. 1997).
Debt collector. Stanley Tulchin Associates, Inc. v. Vignola, 186 A.D. 2d 183, 587
N.Y.S.2d 761 (2d Dep’t 1992).
Electrologist. Curtis v. Amela-Bouyea, 137 A.D.2d 944, 525 N.Y.S.2d 686
(3d Dep’t 1997)
Optician / Ophthalmic Dispensing. Carpenter & Hughes v. De Joseph, 10 N.Y.2d 925,
224 N.Y.S.2d 9 (1961).
Electrical engineer. Support Systems Associates, Inc. v. Tavolacci, 135 A.D.2d 704, 522
N.Y.S.2d 604 (2d Dep’t 1987).
Vaudeville performer. Shubert Theatrical Co. v. Gallagher, 206 A.D. 514, 201 N.Y.S.
577 (1st Dep’t 1923).
Physician. Gelder Medical Group v. Webber, 41 N.Y.2d 680, 394 N.Y.S. 2d 867 (1977).
Recording artist. King Records, Inc. v. Brown, 21 A.D.2d 593, 252 N.Y.S.2d 988 (1st
Dep’t 1964).
Salesperson of balloon bouquets. Deborah Hope Doelker, Inc. v. Kestly, 87 A.D.2d 763,
449 N.Y.S.2d 52 (1st Dep’t 1982).
Crop sprayer. S & S Chopper Service, Inc. v. Scripter, 59 Ohio App. 2d 311, 394 N.E.2d
1011 (Ct. App. Ohio 1977).
Dance instructor. Worrie v. Boze, 191 Va. 916, 62 S.E.2d 876 (1951).
Magazine publisher. Gorman Publishing Co. v. Stillman, 516 F. Supp. 98 (N.D. Ill.
1980).
Tire analyst. Uniroyal Goodrich Tire Co. v. Hudson, 873 F. Supp. 1037 (E.D. Mich.
1994).
2.
Consideration
Traditionally, where a restrictive covenant is executed as part of an original employment
agreement at the time employment is accepted, the offer of employment is considered adequate
consideration for the covenant. However, when an employer seeks to impose restrictive
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covenants after the employment period has begun, state laws vary on what constitutes adequate
consideration.
a.
Jurisdictions Requiring Independent Consideration
Some states require independent consideration for a non-compete agreement executed
after employment begins. For example, under Minnesota law, continuation of employment is
adequate consideration only if the agreement is bargained for and provides the employee with
“real advantages.” Midwest Sports Marketing, Inc. v. Hillerich & Bradsby of Canada, 552
N.W.2d 254, 266 (Minn. Ct. App. 1996) (holding that a non-compete covenant between a sales
agency and a salesperson failed for lack of consideration because “absolutely no distinction was
made between signers and nonsigners”). The court noted that one of its primary concerns was
the unequal bargaining power between employers and employees once employment had begun.
Midwest Sports, 552 N.W.2d at 265; see also Northwest Publications, L.L.C. v. The Star Tribune
Co., No. C6-07-003489, 2007 WL 2791691 (Minn. Dist. Ct. Sept. 18, 2007) (finding employee
non-compete agreements invalid when signed by existing employees because they were not
supported by independent consideration).
Pennsylvania also generally requires independent consideration for a non-compete
beyond continued employment. Insulation Corp. of America v. Brobston, 446 Pa. Super. 520,
529, 667 A.2d 729, 733 (Pa. Super. 1995) (holding that $2,000 annual raise and “change of
employment status from ‘at-will’ to a written year-to-year term upon signing the agreement was
adequate consideration” for a non-compete between an insulation manufacturer and its national
account manager). However, a recent federal court decision applying Pennsylvania law held that
under the Uniform Written Obligations Act (codified at 33 Pa. Cons. Stat. Ann. § 6), a written
agreement shall not be avoided for lack of consideration if it contains language expressing the
intent of the parties to be legally bound by the agreement. Latuszewski v. Valic Fin. Adv. Inc.,
No. 03-0540, 2007 WL 4462739, *10 (W.D.Pa. Dec. 19, 2007). The court held that a provision
in an employment agreement stating that the parties agreed to be bound by the contract was a
valid substitute for consideration needed to support the restrictive covenant.
In Washington, sufficient independent consideration to support the imposition of a
restrictive covenant subsequent to the time of hire “may include increased wages, a promotion, a
bonus, a fixed term of employment, or perhaps access to protected information.” Labriola v.
Pollard Group, Inc., 152 Wash.2d 828, 834 (2004). At least one lower court has held that “a
specific and credible threat of discharge [for refusal to sign a restrictive covenant] and continued
at-will employment for a substantial time thereafter” may constitute sufficient consideration.
Spacelabs Med., Inc. v. Farah, No. 40993-0-I, 1999 WL 142424, at *3 (Wash. App. Div.3, Mar.
15, 1999).
b.
Jurisdictions Where Continued Employment May be Sufficient
Consideration
In some jurisdictions, continuing the employment relationship alone may constitute
sufficient consideration. In Illinois, continued employment is adequate consideration to support a
restrictive covenant only if the employment actually continues for a “substantial period of time”
after the execution of the restrictive covenant. Brown & Brown v. Mudron, 887 N.E.2d 437 (Ill.
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App. 3d Dist. 2008); Woodfield Group, Inc. v. DeLisle, 693 N.E.2d 464, 469 (Ill. Ct. App. 1998)
(“substantial” continued employment may constitute sufficient consideration). The Brown court
held that two or more years of continued employment would be adequate consideration, but that
seven months of continued employment after execution of the restrictive covenant was not
sufficient consideration to support the restrictive covenant even though the employee voluntary
resigned after seven months and was not terminated by the employer.
Massachusetts law regarding whether continued employment alone is sufficient
consideration for a restrictive covenant is unsettled. The highest Massachusetts court to have
addressed the consideration issue held that continued employment of an at-will employee is
sufficient to support the imposition of a restrictive covenant subsequent to the time of hire.
Wilkinson v. QCC, Inc., 53 Mass. App. Ct 1109, 1109 (Mass. App. Ct. 2001). Two lower
courts, relying on a District of Massachusetts case, subsequently held that continued employment
is insufficient, without discussion of the Wilkinson case. Engineering Mgm’t Support, Inc. v.
Puca, No. MICV200501082, 2005 WL 1476462, *1 (Mass. Super. Apr. 11, 2005) (citing IKON
Office Solutions, Inc. v. Belanger, 59 F. Supp. 2d 125 (D. Mass. 1999) (“At bottom, the
[Massachusetts] courts now appear to refuse to enforce non-competition and non-solicitation
agreements when the only purported consideration is the employee’s continued employment.”)
(collecting cases)); Rellstab v. John Hancock Fin. Serv., Inc., No. 011281B, 2004 WL 1050748,
*1 (Mass. Super. Mar. 24, 2004). Most recently, a Massachusetts trial court held that the
employer’s providing access to confidential information was consideration sufficient to support a
restrictive covenant. See EMC Corp. v. Donatelli, No. 091727BLS2, 2009 WL 1663651, *6
(Mass. Super. Ct. Suffolk Cty. May 5, 2009) (not reported) (continued employment paired with
access to confidential information or trade secrets is sufficient consideration).
In New York, the principal case on consideration for a non-competition covenant is
Zellner v. Conrad, 183 A.D.2d 250, 589 N.Y.S.2d 903 (2d Dep’t 1992). In that case, the court
held that a non-compete covenant entered into during at-will employment is not void for lack of
consideration if termination is the alternative to signing the agreement or the employee remains
with the employer for a substantial time after the covenant is signed. 589 N.Y.S.2d at 907
(finding a non-compete entered into between a doctor and a medical partnership was valid
without additional consideration). The rationale is that in an at-will employment arrangement,
the employer has the right to terminate the employee at any time and “forbearance of that right is
a legal detriment which can stand as consideration for a restrictive covenant.” Id. New York
courts have continued to follow this precedent. In Int’l Paper Co. v. Suwyn, 951 F. Supp. 445
(S.D.N.Y. 1997), injunction denied and claim dismissed, 966 F. Supp. 246 (S.D.N.Y. 1997), the
court held that a non-compete covenant between a paper company and one of its senior
executives was valid without additional consideration, stating that forbearance from the right to
discharge without cause was a legal detriment which forms consideration for the restrictive
covenant. See also Gazzola-Kraenzlin v. Westchester Med. Grp., P.C., 10 A.D.3d 700, 782 (2d
Dep’t 2004) (“[T]he plaintiff’s continued employment by the defendant until December 31,
2002, constituted good and sufficient consideration for the restrictive covenants, notwithstanding
the at-will nature of the employment relationship.”); 13A N.Y. Prac., Employment Law in New
York § 2.5 (2004); Hogan v. Bergen Brunswig Corp., 153 N.J. Super. 37, 378 A.2d 1164 (N.J.
Super. Ct. 1977) (continued employment constituted sufficient consideration).
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Against the backdrop of the earlier cases dealing with consideration, New York several
years ago introduced the notion that an employer’s compensation of an employee for the period
of time the employee is restricted from competing may enhance the prospect that a covenant notto-compete will be enforced. Though the requirement is most often discussed from the
standpoint of striking an appropriate equitable balance in the context of injunctive proceedings, it
can also be viewed as a consideration issue and is worthy of mention here. In The Estee Lauder
Companies Inc. v. Batra, 430 F. Supp. 2d 158, 182 (S.D.N.Y. 2006) the court enforced a noncompete agreement against a former executive and granted Estee Lauder’s request for a
preliminary injunction because, inter alia, the hardship on the executive was “entirely mitigated
by the fact that Estee Lauder will continue to pay Batra his salary of $375,000 per year for the
duration of the ‘sitting out’ period. While he will not be permitted to engage in any employment
of his choosing, he will receive due consideration for fulfillment of his agreement not to work for
a competitor.” Similarly, in Lumex, Inc. v. Highsmith, 919 F. Supp. 624, 636 (E.D.N.Y. 1996),
the court found that the fact that the former marketing manager was to receive his full base salary
plus premiums for health and life insurance during the restrictive period was one of the “fair and
reasonable counterbalancing provisions” in the non-compete covenant which rendered the
agreement enforceable. See also Int’l Business Machines Corp. v. Papermaster, No. 08-CV09087 (KMK), 2008 WL 4974508, *13 (S.D.N.Y. Nov. 21, 2008) (granting IBM’s motion for
preliminary injunction against former executive and enforcing restrictive covenants where,
among other things, IBM “offered to increase [executive’s] salary to stay employed at IBM or to
pay him a year’s salary not to work for Apple”). The court in Maltby v. Harlow Meyer Savage,
Inc., 166 Misc. 2d 481, 633 N.Y.S.2d 926 (N.Y. Sup. Ct. 1995), aff’d, 223 A.D.2d 516, 637
N.Y.S.2d 110 (1st Dep’t 1996), noted that the fact that the brokers were to receive their full base
salary during the restrictive period was one of the factors it considered in upholding the
agreement. 166 Misc. 2d at 486 (“[T]he restrictive covenants are reasonable in that each protects
the employer from severe economic injury while--at the same time--it protects the employee’s
livelihood, by requiring that he be paid his base salary.”); see also MTV Networks v. Fox Kids
Worldwide, Inc., No. 605580/97, 1998 WL 57480 (N.Y. Sup. Ct. N.Y. County Feb. 4, 1998)
(enforcing non-compete clause where employer offered to pay the employee his $375,000 salary
and $400,000 in bonuses); Amroc Investments, Inc. v. Sizer, N.Y. L.J., Nov. 6, 1997, at 25
(N.Y. Sup. Ct. N.Y. County 1997) (lack of compensation payable to an employee during the
term of a non-compete agreement was an important factor in its decision to reduce enforcement
of the agreement from one-year to two-months); Harlow Meyer Savage v. Saez, No. 101852/95
(N.Y. Sup. Ct. February 17, 1995) (preliminary injunction issued “on condition that the plaintiff
continue to compensate him at the rate he was compensated, his basic salary at the time he
terminated his employment”). Typically, payment is considered as merely one factor among
many in the analysis of the reasonableness of restrictive covenants. As the above cases suggest,
New York courts will find restrictive covenants that provide for payment to be sufficiently
narrowly drawn, reasonable, and enforceable. See e.g., Natsource LLC v. Paribello, 151 F.
Supp. 2d 465, 472 (S.D.N.Y. 2001) (covenant provided for payment during a ninety-day notice
period and a three-month sitting-out); SG Cowen Sec. Corp. v. Messih, No. 00 Civ. 3228, 2000
WL 633434, at *4 (S.D.N.Y. May 17, 2000) (provided for the employee to receive a base salary
of $20,000 per month plus benefits was reasonable), aff’d, 224 F.3d 79 (2d Cir. 2000). But see
Baxter Int’l Inc. v. Morris, 976 F.2d 1189, 1195, 1197 (8th Cir. 1992) (affirming denial of
preliminary injunction enforcing one year non-compete covenant even though the biological
research company had agreed to pay the employee for its duration).
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Neither the inclusion nor exclusion of a compensation provision, however, should be
dispositive of whether or not a restrictive covenant will be enforceable. In Ticor Title Ins. Co. v.
Cohen, 173 F.3d 63 (2d Cir. 1999), the court enforced a non-compete agreement and rejected
defendant’s attempt to distinguish cases where compensation was provided, noting that public
policy concerns regarding impairment of an individual’s rights to earn a livelihood were not
implicated because “part of defendant’s $600,000 salary was in exchange for his promise Not-toCompete for six months.” More recently, in an unpublished decision, the New York Supreme
Court, citing Ticor, noted that payment of salary during the non-compete period is not a
condition to enforcement, including through preliminary injunctive relief, but merely “‘help[s]
alleviate the policy concerns that non-compete provisions prevent a person from earning a
livelihood.’” In Creditex, Inc. v. Eddy, No. 600755/04 (N.Y. Sup. Ct. N.Y. County, April 16,
2004) (Friedman, J.), the court concluded that where the restraint does not prevent the employee
from working for a competitor, but restrains the employee from dealing with certain customers,
post-termination compensation is not required to support an injunction. Similarly, the court in
Payment Alliance Int’l, Inc. v. Ferreira, 530 F. Supp. 2d 477 (S.D.N.Y. 2007) enforced a two
year non-compete clause against a technology company executive even though the clause did not
provide for the payment of the executive’s salary during the non-compete period. In so holding,
the court noted that “while courts will consider whether an employee receives continued
consideration for his loyalty and goodwill, this factor is not dispositive.” Payment Alliance, 530
F. Supp. 2d at 485 (internal citations and quotations omitted).
c.
The Special Case of Texas
The Texas Covenants Not-to-Compete Act provides that “a covenant Not-to-Compete is
enforceable if it is ancillary to or part of an otherwise enforceable agreement at the time the
agreement is made to the extent that it contains limitations as to time, geographical area, and
scope of activity to be restrained that are reasonable and do not impose a greater restraint than is
necessary to protect the goodwill or other business interest of the promisee.” Tex. Bus. & Com.
Code § 15.50. Texas courts have held under the Act that an otherwise enforceable agreement
can emanate from at-will employment, but only so long as the consideration for a promise is not
dependent on a period of continued employment; any such promise would be illusory given the
employer’s right under the at-will doctrine to discontinue employment at any time in lieu of
performance. See, e.g., Olander v. Compass Bank, 363 F.3d 560, 564-65 (5th Cir. 2004)
(employer’s promises to grant stock options to the employee were found to be illusory given that
the employer could have terminated the employee’s at-will employment at any time without
cause). Moreover, even where an “otherwise enforceable agreement” exists: “(1) the
consideration given by the employer . . . must give rise to the employer’s interest in restraining
the employee from competing; and (2) the covenant must be designed to enforce the employee’s
consideration or return promise. . . .” Light v. Centell Cellular Co. of Texas, 883 S.W.2d 642,
647 (Tex. 1994) (while employer’s definitive promise to train employee was an otherwise
enforceable agreement, covenant Not-to-Compete was not designed to enforce any of
employee’s return promises and was thus invalid).
The Supreme Court of Texas issued a recent decision clarifying that restrictive covenants
are enforceable against an at-will employee even if an employer’s consideration is illusory at the
time the restrictive covenants are entered into so long as the consideration later becomes nonillusory by the employer’s performance. In Alex Sheshunoff Mgm’t Servs., L.P. v. Johnson, 209
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S.W.3d 644, 646–47 (Tex. 2006) an employee entered into an employment agreement containing
restrictive covenants after he had been an employee of a management consulting firm for four
years and after he had received a promotion. Under the agreement, the employer explicitly
promised to provide the employee with access to certain confidential information. When the
employee later defected to a competitor, the Supreme Court of Texas found the restrictive
covenants to be enforceable because the employer had followed through on its promise to
provide the former employee with confidential information. Johnson, 209 S.W.3d at 647, 651.
Additionally, the Texas Supreme Court recently held that a restrictive covenant was
enforceable where the court determined that the employer made an implied promise to provide
confidential information to the employee and the employer actually followed through on the
promise to provide access to confidential information. The court held that an employer
impliedly promises to provide confidential information when the nature of the employee’s work
requires confidential information to be provided for the work to be performed by the employee.
Mann Frankfort Stein & Lipp Adv. Inc. et al. v. Fielding, 289 S.W.3d 844 (Tex. 2009) (holding
that implied promise to provide confidential information is sufficient consideration if the
confidential information is in fact provided to employee).
The lesson to be learned from these examples is to check the applicable state law before
presuming to impose a restraint on existing employees.
3.
The Employer’s Protectible Interest
Non-compete covenants are viewed with skepticism by the courts because they often
operate to restrain trade and prevent an individual from earning a livelihood in his or her chosen
profession. In order to equitably balance the interests of the employee in earning a livelihood
with the employer’s interest in protecting against economic injury, courts will enforce restrictive
covenants only to the extent that they are reasonable. Normally, the threshold issue considered
by the courts is whether the employer has a legitimate interest which may be protected by a noncompete agreement. Ivy Mar Co. v. C.R. Seasons, 907 F. Supp. 547, 555-56 (E.D.N.Y. 1995)
disapproved on other grounds, Faively Transport Malmo AB v. Wabtec Corp., 559 F.3d 110, 118
(2d Cir. 2009). To determine whether a protectible interest has been shown, courts generally
consider whether the covenant protects “trade secrets” or whether the employee’s services are
“unique or extraordinary.” Id. at 555; Reed, Roberts Associates, Inc., v. Strauman, 40 N.Y.2d
303, 308, 386 N.Y.S.2d 677, 680 (1976); Int’l Paper Co. v. Suwyn, 951 F. Supp. 445, 449
(S.D.N.Y. 1997), injunction denied and claim dismissed, 966 F. Supp. 246 (S.D.N.Y. 1997).
a.
Trade Secrets
A trade secret is generally defined as information (a) that affords the owner a competitive
advantage and is not available in the general public and (b) that the owner has taken reasonable
steps to keep confidential. Delta Filter Corp. v. Morin, 108 A.D.2d 991, 485 N.Y.S.2d 143 (3d
Dep’t 1985); Sun Dial Corp. v. Rideout, 16 N.J. 252, 257, 108 A.2d 442 (1954); Courtesy Temp.
Service, Inc. v. Camacho, 222 Cal. App. 3d 1278, 272 Cal. Rptr. 352 (Ct. App. 1990);
Restatement (Third) of Unfair Competition § 39 (1995). Courts may consider the following six
factors to determine whether information is a trade secret: (1) the extent to which the
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information is known outside of the business; (2) the extent to which the information is known
by employees and others involved in the business; (3) the extent of measures taken to protect the
secrecy of the information; (4) the value of the information to the business and its competitors;
(5) the amount of effort or money expended in developing the information; and (6) the ease or
difficulty with which the information could be acquired or duplicated. See The Estee Lauder
Cos. Inc. v. Batra, 430 F. Supp. 2d 158, 175 (S.D.N.Y. 2006); Jay’s Custom Stringing, Inc. v.
Yu, No. 01 Civ. 1690 (WHP), 2001 WL 761067 (S.D.N.Y. 2001); Ashland Mgmt. v. Janien, 82
N.Y.2d 395, 604 N.Y.S.2d 912 (1993).
Many jurisdictions have adopted the Uniform Trade Secret Act which defines a trade
secret broadly as information that derives independent economic value, actual or potential, from
not being generally known to, and not being readily ascertainable through proper means by other
persons who can obtain economic value from its disclosure or use; and, be the subject of efforts
that are reasonable under the circumstances to maintain secrecy. See, e.g., Cal. Civ. Code §
3426.1(d) (West 1997). Under this definition, business plans, projections, strategic initiatives,
market research and analysis, customer characteristics and related business data may be subject
to protection. In addition, the Economic Espionage Act of 1996, 18 U.S.C. §§ 1831-39, imposes
criminal penalties for the appropriation of trade secrets where the perpetrator does so “knowing
that the offense will benefit any foreign government, foreign instrumentality, or foreign agent.”
Prosecution under this statute is within the sole discretion of the Department of Justice.
Violations of this section carry penalties of up to fifteen years in prison, fines of up to $500,000
for individuals, and fines of up to $10,000,000 for organizations.
In recent years, much of the debate regarding trade secrets has centered on customer lists
and other information gathered on an employer’s customers. Unlike technical and scientific
information, which are easily recognized as trade secrets, an employer seeking protection for a
customer list must show that it expended substantial time, money or effort in developing the list.
Leo Silfen, Inc. v. Cream, 29 N.Y.2d 387, 393, 328 N.Y.S.2d 423, 427 (1972) (“[W]here
customers are not known in the trade or are discoverable only by extraordinary efforts, courts
have not hesitated to protect customer lists and files as trade secrets . . . especially where the
customers’ patronage ha[s] been secured by years of effort and advertising effected by the
expenditure of substantial time and money.”); Eastern Bus. Sys., Inc. v. Specialty Bus. Solutions,
LLC, 292 A.D.2d 336, 338 (2d Dep’t 2002) (affirming trial court’s order precluding former
employees from using customer lists and files where former employer presented evidence
showing “information in question was not available to public, was available to limited personnel
inside [employer], was highly valuable to [employer] and its competitors, and that considerable
effort and money was expended in obtaining the information”); Patient Transfer Sys., Inc. v.
Patient Handling Solutions, Inc., No. 97-1568, 2001 WL 936641 (E.D. Pa. Aug. 16, 2001)
(reasoning that “confidential customer lists can be protected under Pennsylvania law” unless they
are readily obtainable from publically available sources); McLaughlin, Piven, Vogel Inc. v. W.J.
Nolan, 114 A.D.2d 165, 498 N.Y.S.2d 146 (2d Dep’t 1986) (holding that a financial services
company met this standard and customer list was therefore a trade secret). But compare Ivy Mar
Co. v. C.R. Seasons, 907 F. Supp. 547, 557 (E.D.N.Y. 1995) (employer failed to establish that
list was confidential, that it conferred a business advantage or that substantial time, money or
effort was expended to generate it). There must be a factual basis for an assertion that a
customer list is confidential and worthy of protection; unsupported statements may be rejected as
conclusory. Empire Farm Credit ACA v. Bailey, 239 A.D.2d 855, 657 N.Y.S.2d 211, 212 (3d
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Dep’t 1997) (rejecting employer’s contention that time, money and effort were invested where
evidence indicated that list was generated primarily using referrals); Bus. Networks of New
York, Inc. v. Complete Network Solutions, Inc., 265 A.D.2d 194, 194-95, 696 N.Y.S.2d 433,
435 (1st Dep’t 1999) (denying preliminary injunction absent evidence that confidential
information existed and that defendants appropriated it); Millennium Communications Inc. v.
Garvan Communications, Inc., No. 72700520/99, N.Y. L.J., Dec. 2, 1998, at 25 (N.Y. Sup. Ct.
N.Y. County) (McCaffrey, J.) (denying preliminary injunction motion where it could not be
stated as a matter of law that information regarding pricing strategy and cost methodology was
improperly seized).
Customer lists that can readily be obtained through publicly available sources are
routinely denied trade secret status because by definition, they are not confidential. Riedman
Corp. v. Gallager, 48 A.D.3d 1188 (4th Dep’t 2008) (customers that could be located through
telephone books, trade publications, referrals and social contacts did not constitute confidential
or trade secret information); Primo Enterprise v. Bacher, 148 A.D.2d 350, 351, 539 N.Y.S.2d
320, 321 (1st Dep’t 1989) (information obtained through industry publications was not a trade
secret); Briskin v. All-Seasons Services, Inc., 206 A.D.2d 906, 615 N.Y.S.2d 166 (4th Dep’t
1994) (customer list compiled using “yellow pages” telephone book was not a trade secret); Ivy
Mar Co. v. C.R. Seasons, 907 F. Supp. 547, 558 (E.D.N.Y. 1995) (customer list compiled from
books identifying large retailers in the industry was not a trade secret); Abraham Zion Corp. v.
Lebow, 593 F. Supp. 551, 564 (S.D.N.Y. 1984) (employee who contacted customers based on
previous personal associations did not appropriate a trade secret), aff’d, 761 F.2d 93 (2d Cir.
1985). Similarly, information about specific customers is generally not considered a trade secret.
Tactica Int’l, Inc. v. Atlantic Horizon Int’l, Inc., 154 F. Supp. 2d 586, 606 (S.D.N.Y. 2001)
(remembered information as to “specific needs and business habits of a particular customer” is
not confidential) (quoting Catalogue Service of Westchester, Inc. v. Henry, 107 A.D.2d 783,
784, 484 N.Y.S.2d 615, 616 (2d Dep’t 1985)).
However, when other factors are present, a recreatable customer list may be entitled to
trade secret protection. See, e.g., U.S. Trust Corp. v. Cowperthwait Partners, No. 601272/99
(N.Y. Sup. Ct. 1999) (Cozier, J.) (restraining the use of customer-related information by former
employees which included a list of customers whose identities might have been recreated from
public sources because together with other information about their assets and characteristics it
constituted a compilation of information that the employer took extensive steps to protect and
which was not available to the general public) (unpublished opinion). It should be noted that the
actual physical taking of a customer list, regardless of availability or the amount of time spent by
the employer in developing it, may under New York, “‘give rise to a breach of fiduciary duty,’
even if those lists do not constitute trade secrets or confidential information.” Cray v.
Nationwide Mutual Ins. Co., 136 F. Supp. 2d 171, 177 (W.D.N.Y. 2001) (quoting In re UFG
Int’l, Inc., 225 B.R. 51, 57 (S.D.N.Y. 1998)).
Assuming an employer is able to demonstrate that the information is confidential and is
the product of time, money and effort, another relevant consideration may be the time sensitivity
of the customer information. In Amroc Investments, Inc., N.Y. L.J., Nov. 6, 1997, a brokerage
firm specializing in the securities of distressed companies sought to enjoin the defendant from
working for a competitor. The employer maintained that as a “sourcer,” the defendant employee
obtained confidential information about locating and analyzing the bank debt of the various
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companies. The court found that such information did not constitute a trade secret in part
because “[b]y its very nature, the information is dated and will soon become stale and of no use.”
See also EarthWeb Inc. v. Schlack, 71 F. Supp. 2d 299, 305 (S.D.N.Y. 1999) (declining to
enforce non-compete agreement where, among other things, employee’s knowledge of
employer’s proprietary information “may soon become obsolete”); Bus. Intelligence Services,
Inc. v. Hudson, 580 F. Supp. 1068 (S.D.N.Y. 1984) (enforcing non-compete agreement, noting
that “[w]ithin a year [defendant’s] knowledge of these matters will be outdated and of little
use”).
In addition to customer information, another issue of contention has been an employer’s
right to keep its operations and business approach confidential. However, the courts uniformly
hold that generic knowledge of the nature and operation of an employer’s business alone is not
considered a trade secret. Catalogue Service of Westchester, Inc. v. Henry, 107 A.D.2d 783,
784, 484 N.Y.S.2d 615, 616 (2d Dep’t 1985) (absent a wrongdoing, “knowledge of the
intricacies of a business operation” does not constitute a trade secret); Anchor Alloys v. NonFerrous Processing Corp., 39 A.D.2d 504, 507, 336 N.Y.S.2d 944 (2d Dep’t 1972) (employee
could not be enjoined from using his knowledge of the metal field industry); Prebon Yamane
(USA) Inc. v. Cantor Fitzgerald, L.P. et al., No. 134959/94 (N.Y. Sup. Ct. N.Y. County 1995)
(absent some wrongdoing, defendant’s use of his knowledge of the plaintiff’s inter-bank
brokerage operations did not constitute misappropriation of a trade secret); RMJ Securities Corp.
v. Minardi, No. 113831/95 (N.Y. Sup. Ct. N.Y. County 1995) (knowledge of the securities
brokerage industry could not be considered a trade secret and thus defendant could not be
enjoined from utilizing the information he accumulated over the years); Silipos, Inc. v. Bickel,
No. 1:06-cv-02205, 2006 WL 2265055 (S.D.N.Y. Aug. 8, 2006) (knowledge of medical device
manufacturer’s marketing sales reports, gross margin reports, future marketing plans, product
specifications and pricing information did not trigger trade secret protection). “Wrongdoing”
that might justify a finding of misappropriation may include stealing or studied memorization.
Greenwich Mills Co. v. Barrie House Coffee Co., 91 A.D.2d 398, 402, 459 N.Y.S.2d 454 (2d
Dep’t 1983); Leo Silfen, Inc. v. Cream, 29 N.Y.2d 387, 328 N.Y.S.2d 423 (1972).
Whether or not information will be considered a protectible trade secret sufficient to
support a covenant not-to-compete depends on the facts of the given case. The decision turns on
the nature of the business, the circumstances surrounding the preparation or collection of the
information, the manner in which the information is maintained and safeguarded by a company
and the degree of competitive advantage that such information would provide to a competitor
who obtained the information without its owner’s consent.
b.
Unique or Extraordinary Employee Services
Employers also have a protectible interest in employees’ services which are “unique or
extraordinary.” Courts have found employees to meet this criteria where they have unique
relationships with customers or particularly comprehensive knowledge of the employer’s
strategic goals and business plans. In order for an employee’s services to be sufficiently unique
and extraordinary to constitute a protectible interest, courts have previously held that it must be
impossible to replace the employee or the loss of the employee must cause the employer
irreparable injury. Purchasing Associates, Inc. v. Weitz, 13 N.Y.2d 267, 246 N.Y.S.2d 600
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(1963); accord Ingersoll-Rand Co. v. Ciavatta, 110 N.J. 609 (1988). In the recent case, Ticor
Title Ins. Co. v. Cohen, 173 F.3d 63, 71 (2d Cir. 1999), the Second Circuit explained that the
focus of the inquiry should be on the employee’s relationship to the employer and the value of
his services, rather than on the individual’s special talents. Likewise, the Southern District of
New York recently concluded that an employer must show more than the fact that the employee
is an excellent worker or that his “services are of high value to his employer.” See, e.g.,
Heartland Sec. Corp. v. Gerstenblatt, No. 99 Civ. 3694, 2000 WL 303274, *8 (S.D.N.Y. Mar. 22,
2000).
With regard to customer relationships courts have found that employers have a legitimate
interest in protecting the “unique” relationship that an employee develops with the employer’s
clients or an interest in protecting “customer relations.” Leon M. Reimer & Co. v. Cipolla, 929
F. Supp. 154, 158 (S.D.N.Y. 1996) (employer “entitled reasonably to protect itself from the risk
that an employee . . . may later . . . misappropriate the benefits of relationships developed at [the
employer’s] expense.”); Neveaux v. Webcraft Technologies, Inc., 921 F. Supp. 1568, 1571 (E.D.
Mich. 1996) (“New Jersey courts expressly ‘recognize as legitimate the employer’s interest in
protecting . . . customer relations’”) (quoting Ingersoll-Rand Co., 110 N.J. 609)); Ticor Title Ins.,
173 F.3d at 71 (finding employee’s services unique in light of the importance of personal
relationships in a market where insurance costs and terms are fixed by law and the limited
number of potential clients). Employers in the financial services industry, for example, have had
success in establishing that an employee’s services are “unique or extraordinary.” Maltby v.
Harlow Meyer Savage, Inc., 166 Misc. 2d 481, 633 N.Y.S.2d 926 (N.Y. Sup. Ct. 1995), aff’d,
223 A.D.2d 516, 637 N.Y.S.2d 110 (1st Dep’t 1996) (finding that brokers on the forward
dollar/mark desk had unique relationships with the customers that had been developed while
employed by the plaintiff, and partially at plaintiff’s expense); Harlow Meyer Savage v. Saez,
No. 101852/95 (preliminary injunction granted where personal relationships developed as a
currency exchange broker required a six-month training and development period); GFI Brokers,
LLC v. Giardina, Index No. 600927/07 (Slip Op.), 2007 WL 2175578, at *6 (Sup. Ct. N.Y. Co.
Apr. 20, 2007) (enforcing restrictive covenant and holding that former employee’s services to
inter-dealer broker “were unique because of the special relationship the company enabled him to
develop with customers”). But see Tradition Chile Agentes de Valores Ltda. v. ICAP Securities
USA LLC, No. 09 Civ. 10343 (WHP), 2010 WL 185656 (S.D.N.Y. Jan. 12, 2010) (denying
inter-dealer broker’s request for injunctive relief because it failed to show brokers’ services were
unique or extraordinary).
Where the employee’s intrinsic value to the company rather than customer relations is the
basis for a claim, courts have been very cautious. See American Broadcasting Cos., Inc. v. Wolf,
52 N.Y.2d 394, 403 n.6, 438 N.Y.S.2d 482, 486 n.6 (1985) (noting that few reported cases are
decided based solely on the uniqueness of an employee’s services); Nigra v. Young Broadcasting
of Albany, 177 Misc. 2d 664, 666, 676 N.Y.S.2d 848, 849 (N.Y. Sup. Ct. 1998) (declining to
enforce restrictive covenant and noting that the unique services argument is “a very slim reed
which has never actually served as the sole basis for judicial enforcement of an anti-competition
clause”). That the employee is a star salesman or top employee may not be sufficient. Diaz v.
Indian Head, Inc., 402 F. Supp. 111 (N.D. Ill. 1975) (fact that employee was one of the top ten
persons in the country qualified to perform those services was insufficient to support a finding of
“unique” services), aff’d, 525 F.2d 694 (7th Cir. 1975); Purchasing Associates, Inc. v. Weitz, 13
N.Y.2d 267, 274, 246 N.Y.S.2d 600, 605 (1963) (it is not sufficient that the employee’s skills be
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of “high value” to his employer). On the other hand, when the employer is very senior and
possesses unique information of the company’s plans a covenant may be enforced. See, e.g.,
Int’l Bus. Machines, Corp. v. Papermaster, No. 08-CV-9078 (KMK), 2008 WL 4974508
(S.D.N.Y. Nov. 21, 2008) (enforcing non-compete against IBM executive who, among other
things, was selected to be a member of “an elite group that develops IBM’s corporate strategy”
and “worked for years with some of the crown jewels of IBM’s technology”); MTV Networks v.
Fox Kids Worldwide, Inc., No. 605580/97, 1998 WL 57480 (N.Y. Sup. Ct. N.Y. County Feb. 4,
1998) (services of former president of cable network found to be “unique and extraordinary”
where he was key in “setting goals and devising strategies for the network, including long term
strategies, strategies for dealing with competitors, and strategies for seizing opportunities before
other competitors, expressly including [his prospective employer],” was the “public face” of his
former employer, had “regular contact” and “excellent relations” with the trade press and
appeared at industry conventions, “where personal relationships are invaluable”). But see
Lucente v. Int’l Bus. Machines, Corp., 117 F. Supp. 2d 336, 348-49 (S.D.N.Y. 2000) (noting that
despite plaintiff’s position as a senior executive and President of Asian-Pacific operations,
“innate management skills and general know how are exactly the kind of information that cannot
be restricted through a covenant not-to-compete”), rev’d, 310 F.3d 243 (2d Cir. 2002), motion
granted, 262 F. Supp. 2d 109 (S.D.N.Y. 2003) (granting employee motion to require the
employer to provide information and documents regarding the employer’s interpretation and
enforcement of noncompetition agreements).
In practice then, the objective of an employer attempting to restrain an employee based
on his unique and extraordinary services will be to emphasize the ways in which the employee’s
skills, know-how and contacts cannot be replicated, or on the sensitivity of highly confidential
business plans and strategies. The employee’s emphasis will be on the existence of other
employees who are able to perform the same functions and the lack of sensitivity of the business
information.
c.
Goodwill
A Massachusetts court has upheld an employer’s right to protect its “goodwill.”
McFarland v. Schneider, 11 Mass. L. Rep. 711, 1998 WL 136133 (Mass. Super. Ct. 1998).
The defendant in McFarland was a former partner of Wellington Management Company,
an investment advisory and management firm servicing primarily institutional investors. In
1996, he left the company in order to start his own investment management business.
Wellington sued to enforce the non-compete clause in the executive’s contract which prohibited
him from soliciting or accepting business from any Wellington client for a period of five years or
from participating in any business in competition with Wellington for a period of three years. Id.
at *20. The protectible interests alleged were (a) Wellington’s external goodwill, i.e. its
“positive reputation in the eyes of its clients and potential clients,” and (b) its internal goodwill,
i.e. its “close relationships between its own employees” and “its own relationship with
employees whom it has placed in a position to form client relationships.” Id. at *42. Discussing
“internal goodwill” the court reasoned that if employees could freely walk off with the
customers, employees would generally lose confidence in one another and this would reduce the
willingness of employees to share information and to support one another in their business
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development efforts. It was that effort that contributed to the high quality of service provided to
customers and to the external goodwill of the company. The court enforced the five year ban on
solicitation of certain customers, but declined to enforce the three year prohibition on
competition given the significant impact on the defendant’s earning ability and the unnecessary
breadth of the ban. Id. at *41-42.
BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 690 N.Y.S.2d 854 (1999), recognized the
employer’s right to protect the “goodwill of clients [ ] acquired through the expenditure of
[employer’s] resources.” See also Kelly v. Evolution Markets, Inc., 626 F. Supp. 2d 364
(S.D.N.Y. 2009) (finding employer had a legitimate business in enforcing restrictive covenants
to protect its “goodwill that it fostered with customers”); GFI Brokers v. Doyle, Index No.
106596/03 (Sup. Ct. N.Y. County May 2, 2003) (irreparable harm found based on inter-dealer
broker’s loss of client relationships, loss of goodwill, and loss of standing in competitive
community); American Express Financial Advisors Inc. v. Walker, 9 Mass. L. Rep. 242, 1998
WL 754620, *24 (Mass. Super. Ct. Oct. 28, 1998) (holding that it is “reasonable for American
Express to attempt to protect its goodwill and its confidential information regarding the identities
of . . . clients through some form of restrictive covenant”). Courts have long recognized an
employer’s interest in protecting its “goodwill,” in the context of an agreement Not-to-Compete
with the purchaser following the sale of a business. Meteor Indus. Inc. v. Metalloy Indus., Inc.,
104 A.D.2d 440, 479 N.Y.S.2d 61 (2d Dep’t 1984) (where a sale of a business occurs,
“consideration for which was in part payment for the goodwill of the business a covenant
restricting [the seller’s] right to compete with the purchaser is enforceable”). Indeed, in New
York there is an implied covenant not to solicit clients of a former employer or to impair
goodwill sold in connection with the sale of a business. Mohawk Maintenance Co., Inc. v.
Kessler, 52 N.Y.2d 276, 437 N.Y.S.2d 646 (1981). Courts recognize the goodwill as inseparable
from the identity of the sold business, and will thus treat it more like a trademark or proprietary
information. Hay Group, Inc. v. Nadel, 566 N.Y.S.2d 616, 617 (1st Dep’t 1991); Misys Int’l
Banking Sys., Inc. v. TwoFour Systems, LLC, No. 650101/2004, 2004 WL 3058144, *15 (N.Y.
Sup. Ct. N.Y. County Nov. 23, 2004).
4.
Reasonableness of the Limitations
Assuming that the employer is able to establish a legitimate protectible interest, the next
step is to determine whether the restrictions themselves are reasonable. American Institute of
Chemical Engineers v. Reber-Friel Co., 682 F.2d 382, 387 (2d Cir. 1982) (“[O]nly after
determining that a restrictive covenant would serve to protect against unfair and illegal conduct
and not merely to insulate the employer from competition, does the reasonableness of its time,
space or scope; or the oppressiveness of its operation become an issue.” (internal citations
omitted)). Restrictions that prevent an employee from pursuing any livelihood are likely to be
struck down. See, e.g., Wilhelmina Models, Inc. v. Major, S.R.L., N.Y. L.J., April 16, 1999, at
27 (N.Y. Sup. Ct. N.Y. County 1999) (invalidating non-compete provision that would have
barred bookers from any economic activity whatsoever in New York, New Jersey, Connecticut
or California for a period of six months). Absent such an over broad prohibition, courts normally
inquire into the reasonableness of the restriction in terms of its geographical scope, the duration
of the non-compete period, the hardship imposed on the employee and other relevant factors.
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a.
Geographic Restrictions
Non-compete covenants often provide restrictions on the geographic area where the
employee may work for a competitor. Such restrictions will be found reasonable only if limited
to a geographic area necessary to protect the employer’s interests. Thus, an employer is entitled
to restrict the former employee’s competition only in the geographic areas in which it operates.
Where an employer fails to demonstrate that it has clients in the geographic area covered by the
agreement, it cannot demonstrate an interest in protecting customer relations that justifies
enforcement of a non-compete agreement. See Lawrence and Allen v. Cambridge Human
Resource Group., Inc., 685 N.E.2d 434, 442 (Ill. App. Ct. 1997). The increasingly national and
international nature of business does seem to have influenced the approach of at least some
courts to the enforcement of covenants with broad geographic scopes. As the Third Circuit noted
in a recent case “[i]n this Information Age, a per se rule against broad geographic restrictions
would seem hopelessly antiquated, and, indeed, Pennsylvania courts (and federal district courts
applying Pennsylvania law) have found broad geographic restrictions reasonable so long as they
are roughly consonant with the scope of the employee’s duties.” Victaulic Co. v. Tieman, 499
F.3d 227 (3rd Cir. 2007).
Courts have upheld covenants with a wide range of geographic scopes. The analysis is
always fact-specific and depends entirely on the geographic arena in which the employer actually
conducts business. Some businesses are inherently worldwide; others are local in nature. Courts
have upheld one-year non-compete covenants with unlimited geographic scope where the scope
of the business is international in nature. See e.g., Bus. Intelligence Services, Inc. v. Hudson,
580 F. Supp. 1068, 1073 (S.D.N.Y. 1984); Branson Ultrasonics Corp. v. Stratman, 921 F. Supp.
909, 913-14 (D. Conn. 1996). In Lumex, Inc. v. Highsmith, 919 F. Supp. 624, 636 (E.D.N.Y.
1996), the court upheld a restrictive covenant which prohibited a former manager of an exercise
equipment manufacturer from working for any competitor regardless of location for six months.
The broad geographical scope was upheld largely because the plaintiff was the largest
manufacturer of such equipment nationwide. Id. Similarly, in Kelly v. Evolution Markets, Inc.,
626 F. Supp. 2d 364 (S.D.N.Y. 2009) the court enforced a non-solicitation clause contained in a
commodity broker’s employment contract even though the clause lacked geographic restrictions.
The court concluded that “although the covenant’s unlimited geographic scope gives the Court
some pause, the broad scope is not unreasonable per se, considering the nature of the
[employer’s] business” which was conducted worldwide over the telephone. Kelly, 626 F. Supp.
2d at 373-74 (internal citations omitted). Contrasting that, the Eastern District of New York
narrowed a restrictive covenant preventing a former employee from providing
telecommunications services anywhere in the world to encompass only the Dominican Republic.
Global Switching Inc. v. Kasper, No. CV 06412 (CPS), 2006 WL 1800001 at *16 (E.D.N.Y.
June 28, 2006). Not all courts, however, will modify an overly broad restrictive covenant. For
example, the Southern District of New York refused to enforce a non-compete clause with the
geographic scope of “anywhere on earth” because of its inherent vagueness. Jay’s Custom
Stringing, Inc. v. Yu, No. 01 Civ. 1690 (WHP), 2001 WL 761067, at *18 (S.D.N.Y. July 6,
2001).
Lack of geographic limitation or overly broad geographic limitation can be “indicia of
unreasonableness and unenforceability.” Leon M. Reimer & Co. v. Cipolla, 929 F. Supp. 154,
160 (S.D.N.Y. 1996); see also SG Cowen Sec. Corp. v. Messih, No. 00 Civ. 3228, 2000 WL
-14-
633434, at *13 (S.D.N.Y. May 17, 2000), aff’d, 224 F.3d 79 (2d Cir. 2000) (“[U]nder New York
law, non-compete agreements that lack geographic restrictions are disfavored and routinely held
unreasonable.”). A Tennessee case reiterated this point stating that “Tennessee courts resist
restrictions unlimited as to place.” Hickory Specialties, Inc. v. Forest Flavors Int’l, Inc., No. 995003, 2000 WL 687681, at *11 (6th Cir. May 19, 2000). But see Mixing Equipment Co. v.
Philadelphia Gear, Inc., 436 F.2d 1308, 1314 (3d Cir. 1970) (although there were no geographic
restrictions, provisions were limited in duration and targeted toward protecting employer’s trade
secrets).
Many courts, including those in New York, may modify an overly broad geographical
limitation, and enforce a more limited restraint.
b.
Duration
Courts must also determine whether the duration of a restrictive covenant is reasonable.
As with considerations of the geographic scope of the covenant, courts have upheld covenants
with a wide range of durations. The litmus test tends to be the amount of time necessary for the
employer to implement steps to recover from the loss of the employee so that competition can be
conducted on a level playing field. One-year non-solicitation restraints have regularly been
enforced in contracts of Merrill Lynch brokers. See Merrill Lynch, Pierce, Fenner & Smith, Inc.
v. Kuile, 222 N.Y. L.J 126, Dec. 30, 1999, at 21 (N.Y. Sup. Ct. N.Y. County 1999) (Kapnick, J);
see also Leake v. Merrill Lynch, 213 A.D.2d 155, 623 N.Y.S.2d 220 (1st Dep’t 1995); U.S. Trust
Co., NA v. Maclachlan, No. 0602908, 2008 WL 168967 (Sup. Ct. N.Y. County Jan. 3, 2008)
(enforcing one year non-solicitation clause); Payment Alliance Int’l, Inc. v. Ferreira, 530 F.
Supp. 2d 477 (S.D.N.Y. 2007) (enforcing two year non-compete); Merrill Lynch, Pierce, Fenner
& Smith, Inc. v. Napolitano, 85 F. Supp.2d 491 (E.D. Pa. 2000); American Express Financial
Advisors Inc. v. Walker, 9 Mass. L. Rep. 242, 1998 WL 754620, *25 (Mass. Super. Ct. Oct. 28,
1998) (“[F]our months is long enough for American Express to assign a replacement financial
advisor and permit that advisor to demonstrate to her new clients her competence and concern,
but not so long (in most economic circumstances) that it will unduly damage the client to sit tight
with American Express and be denied the planning and investment advice of its former financial
advisor.”); Maltby v. Harlow Meyer Savage, Inc., 166 Misc. 2d 481, 486 (N.Y. Sup. Ct. 1995),
aff’d, 223 A.D.2d 516, 637 N.Y.S.2d 110 (1st Dep’t 1996) (upholding six-month restriction in
covenant between brokerage firm and former brokers); Lumex, Inc. v. Highsmith, 919 F. Supp.
624, 636 (E.D.N.Y. 1996) (upholding six-month restriction in non-compete covenant between
fitness machine manufacturer and former account manager); Ivy Mar Co. v. C.R. Seasons, 907 F.
Supp. 547, 559 (E.D.N.Y. 1995) (six-year covenant prohibiting competition in the distribution of
seasonal merchandise industry was not per se unreasonable). In fast-paced industries where
customer relationships are particularly fragile, it is likely that courts will strike an equitable
balance in favor of very limited duration restraints for covenants that prohibit the employee from
working for a competitor. See, e.g., EarthWeb, Inc. v. Schlack, 71 F. Supp.2d 299, 313
(S.D.N.Y. 1999) (rejecting the one-year duration of the restrictive covenant due to the “dynamic
nature” of the Internet industry and its lack of geographic borders), aff’d, 2000 WL 1093320 (2d
Cir. May 18, 2000). The wide range of rulings of the courts regarding geographic scope and
duration provide substantial flexibility in drafting enforceable agreements; however, in each case
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an employer must persuasively demonstrate that the scope and duration of the restraint are
necessary with respect to the employee in question.
c.
Hardship Imposed on the Employee
Although the duration and geographic prohibitions are measured against the harm
imposed on the employee’s livelihood, the courts can also consider the hardship in regard to the
personal circumstances of the employee. In Insulation Corp. of America v. Brobston, 667 A.2d
729 (Pa. Super. 1995), the court listed some of the factors to be reviewed when determining the
harshness and oppression of enforcement of post-employment restrictive covenants including:
the situation of the employee and his family, the employee’s capacity, whether the employee is
handicapped, whether he will be forced to give up the work for which he is best trained, and how
long the employee worked for the employer. Id. at 737. Although these factors may be
considered, no recent cases have cited personal hardship imposed on the employee as a sufficient
justification on its own for invalidating a non-compete covenant, or for that matter, upholding
them based on the lack of hardship on the employee. See, e.g., Corporate Express Delivery
Systems v. Devito, No. 603933/97 (N.Y. Sup. Ct. N.Y. County Jan. 1, 1999) (Cahn, J.)
(invalidating non-solicitation clause that would have barred employee from working for any
entity involved in any products or services in the same geographic area, without regard to
whether he actually serviced their accounts, as an unreasonable limitation on employee’s right to
make a livelihood); Amroc Investments, Inc., N.Y. L.J., Nov. 6, 1997 (reducing the duration of
non-compete contract from one year to two months in part because a longer period would likely
cause the employee to lose a prospective job and preclude her from working in the field
altogether); Int’l Bus. Machines Corp. v. Papermaster, No. 08-CV-9078 (KMK), 2008 WL
4974508, *13 (S.D.N.Y. Nov. 21, 2008) (enforcing non-compete against former IBM employee
despite his claim that his new job with Apple was “a once-in-a-lifetime opportunity for him, as it
[would] involve significantly more responsibility and higher compensation”); Baxter Int’l Inc. v.
Morris, 976 F.2d 1189 (8th Cir. 1992); Ticor Title Ins. Co. v. Cohen, 173 F.3d 63 (2d Cir. 1999)
(noting that a six-month non-compete period was reasonable because “[defendant] is not disabled
from reviving his relationships with clients after the six months’ absence”).
d.
Other Factors
i.
Circumstances of Termination
In determining enforceability of a non-compete covenant, recent cases have also
considered whether the employee quit voluntarily or whether the employee was terminated
through no fault of his or her own.
In Insulation Corp. of America v. Brobston, 446 Pa. Super. 520, 667 A.2d 729, 730 (Pa.
Super. 1995), the court refused to enforce a non-compete covenant between an insulation
manufacturer and its national account manager after the manager was fired for poor performance.
The court noted that “the employer who fires an employee for failing to perform in a manner that
promotes the employer’s business interests deems the employee worthless” and that “it is
unreasonable as a matter of law to permit the employer to retain unfettered control over that
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which it has effectively discarded as worthless . . .” Id. at 735. Similarly, the Court of Appeals
noted that “terminat[ion] of the employment relationship without cause . . . necessarily destroys
the mutuality of obligation on which the covenant [Not-to-Compete] rests. . . .” Post v. Merrill
Lynch, Pierce, Fenner & Smith, Inc., 48 N.Y.2d 84, 89, 421 N.Y.S.2d 847, 849 (1979); In re
UFG Int’l Inc., 225 B.R. 51 (S.D.N.Y. 1998) (barring employer from enforcing non-compete
agreement where employee was not terminated for cause).
The circumstances surrounding termination of the employment agreement may also be a
factor in determining the reasonableness of the non-compete agreement. In New York, whether
the employee resigned or was terminated with or without cause will affect a court’s willingness
to enforce a non-compete agreement. See Morris v. Schroder Capital Mgmt. Int’l, 859 N.E.2d
503 (N.Y. 2006) (“[A]lthough a restrictive covenant [which provides for forfeiture of certain
benefits if an employee engages in post-employment competition] will be enforceable without
regard to reasonableness if an employee left his employer voluntarily, a court must determine
whether forfeiture is ‘reasonable’ if the employee was terminated involuntarily and without
cause.”); Cray v. Nationwide Mutual Life Ins. Co., 136 F. Supp. 2d 171, 179 (S.D.N.Y. 2001)
(“Just as an employer should not be able to use a non-compete agreement offensively by
terminating an employee without cause and then using the agreement both to deny the employee
earned compensation or benefits, and to prevent him from engaging in his chosen livelihood, so
an employee should not be permitted to violate the terms of his employment contract, thereby
giving the employer just cause for terminating him, and yet still be allowed both to compete
with, and still collect benefits from, the former employer after his termination.”). At least on
New York court has refused to enforce a restrictive post-employment covenant when the former
employer breached the employment contract. Michael I. Weintraub, M.D., P.C. v. Schwartz, 516
N.Y.S.2d 946, 948 (2d Dep’t 1987) (employer’s failure to provide written notice to the employee
as to whether he would be offered a partnership at expiration of contract as required by the
contract precluded the employer from seeking to enforce even the reasonable portion of the
restrictive covenant).
Similarly, in South Dakota, whether the employee quit or was fired affects the court’s
analysis of the reasonableness of the non-compete agreement. In Central Monitoring Service,
Inc. v. Zakinski, 553 N.W.2d 513 (S.D. 1996), the court held that “if an employee voluntarily
quits his employment or is fired for good cause . . . no further showing of reasonableness will be
necessary . . . [h]owever, if an employee is fired for no fault of his own, the court needs to go
further to determine whether the agreement is reasonable.” Id. at 520-21.
Courts have also recognized that where an employee has been constructively discharged,
enforcement of a non-compete may be inappropriate. See Wilhelmina Models, N.Y. L.J., April
16, 1999 (employee subjected to sexual harassment was constructively discharged and
enforcement of covenant was denied). One New York court recently rejected an employee’s
attempt to re-cast her voluntary resignation as a constructive discharge in order to avoid postemployment restrictions. In Evolution Markets, Inc. v. Penny, 889 N.Y.S.2d 882, 2009 N.Y.
Slip Op. 51019(u) (Sup. Ct. Westchester County, May 20, 2009) a relatively junior commodities
broker resigned and accepted a job with a competitor approximately three months after her
former supervisor had joined the very same competitor. When the former employer sought to
enforce restrictive covenants in the broker’s employment agreement, the broker claimed that she
had been constructively discharged and that the covenants were unenforceable. While the court
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noted that a post-employment restriction would not be enforceable if the broker had been
involuntarily terminated through a constructive discharge, the court found that the broker’s
constructive discharge claim was unconvincing and granted the former employer’s request for
injunctive relief.
A recent Ninth Circuit case applying the law of the state of Washington held that a
restrictive covenant applied even though the employee was terminated by the employer without
cause. In reaching this ruling, the Ninth Circuit noted that the restrictive covenant explicitly
stated that it was applicable whether the employee was terminated with or without cause.
Steveson v. United Subcontractors Inc., No. 09-35001, 2009 WL 4884497 (9th Cir. 2009).
ii.
Change in the Former Employer’s Status
Another ground for striking down a non-compete agreement may arise where an
employer merges with another company and forms a new company.
An employee successfully evaded enforcement of his non-compete agreement by arguing
that the agreement could not be enforced by the surviving company, Christian Defense Fund
(“CDF”), after its merger with his former employer, Hart Conover Inc. (“HCI”). Despite the fact
that CDF inherited all of HCI’s duties and obligations under its contracts as well as the right to
enforce them, the court agreed with the employee, noting that contracts for personal services
cannot be assigned to or enforced by third parties, unless both parties agree to the assignment.
Because the employee had not consented to an assignment, the surviving company had no right
to enforce the non-compete agreement, or any other provision of the consulting agreement. See
Mullen, “Court Refuses to Enforce Noncompete Following Merger,” Virginia Employment Law
Letter, February 1999; see also Gelsomino v. Trade Advisory Services, Inc., N.Y. L.J., Mar. 15,
1999, at 25 (Cozier, J.) (denying motion for summary judgment where there was an issue of fact
as to whether employer still existed and whether it had any enforceable interest in the noncompete agreement).
However, in several more recent cases, intermediate appellate courts in New York have
held that non-compete agreements are assignable. In Eisner Computer Solutions, LLC v.
Gluckstern, 1998 WL 35251358 (Sup. Ct. N.Y. County Aug. 11, 1998) rev’d 293 A.D.2d 289
(1st Dep’t 2002) the trial court determined that a two-year non-compete agreement contained in a
consultant’s agreement with a computer software company was not enforceable by a third-party
assignee and dismissed the third-party assignee’s breach of contract claim against the consultant.
The First Department reversed finding that the non-compete agreement was assignable under
New York law. The court reached this conclusion even though the contract was silent as to its
assignability. See also James V. Aquavella, M.D., P.C. v. Viola, 39 A.D.3d 1191 (4th Dep’t
2007) (holding trial court properly denied defendant-employee’s motion for summary judgment
because defendant “failed to establish as a matter of law that the agreement was not validly
assigned and that the non-competition provision in the agreement did not remain in effect after
the two assignments”).
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iii.
Hardship Imposed on Third Parties
Where a client’s relationship with his advisor involves a high degree of trust and
confidence, a client’s right to retain the advisor of his choice is an additional consideration for
the courts. See, e.g., U.S. Trust v. Cowperthwait Partners, No. 601272/99 (N.Y. Sup. Ct. 1999)
(Cozier, J.) (enjoining departing employees from soliciting former clients for a period of three
months but refusing to enjoin them from accepting business from clients who chose to utilize
their services) (unpublished opinion); American Express Financial Advisors Inc. v. Walker, 9
Mass. L. Rep. 242, 1998 WL 754620, *22-23 (Mass. Super. Ct. Oct. 28, 1998) (limiting the noncompete period on the theory that “the relationship between a financial advisor and an individual
client . . . is a valuable and important personal and financial relationship whose significance . . .
the common law should not categorically ignore”); Merrill Lynch, Pierce, Fenner & Smith v. De
Liniere, 572 F. Supp. 246 (N.D. Ga. 1983) (“[The] public’s ability to choose the professional
services it prefers is central to the consideration of this criterion of injunctive relief.”). As
discussed in section I.E. below, several trial courts in New York have recently declined to
enforce provisions precluding employees in the financial services industry from providing
services to clients of their former employers on the basis that such enforcement would run afoul
of FINRA rules.
In an interesting twist, clients of departing employees are now challenging the
enforcement of non-compete agreements. In Frank Russell Co. v. Wellington Management Co.,
LLP, 154 F.3d 97 (3d Cir. 1998), former pension fund clients of a capital management company
challenged the enforcement of a five-year non-compete agreement. According to plaintiffs,
Wellington’s enforcement of the non-compete against the departing employee would constitute a
breach of its fiduciary duties under ERISA and the Investment Advisor’s Act of 1940 because
plaintiffs stood to lose $25 million if they were required to change investment advisors during
the non-compete period. The Third Circuit rejected the notion that ERISA or the Investment
Advisor’s Act of 1940 barred Wellington from enforcing the non-compete, holding instead that it
was a “business decision.” Id. at 104. The fact that clients like Frank Russell Co. would no
longer have the investment advisor of their choice was found to have a limited impact on an
ERISA plan. Id. The court further held that Wellington had no duty to disclose the existence of
the non-compete agreement to its clients. Id.
5.
Judicial Modification of Unreasonable
Non-Competition Covenants
Courts generally have the equitable power to modify and limit duration or geographic
scope of a covenant not-to-compete. However, partial enforcement of an unreasonable
restrictive covenant will be carried out only to the extent that is reasonably necessary for the
protection of the employer’s legitimate interests and neither oppressive to the employee nor
contrary to public policy. Courts differ as to the type of restrictions which can be modified and
when the court may make such modifications. Some courts have adopted the “all or nothing”
rule, enforcing a covenant on its face or rejecting it entirely. Other courts use the “blue pencil”
rule, permitting the court to selectively enforce the reasonable provisions of a covenant and
delete the unreasonable provisions (without rewriting or additions) if the resulting agreement is
still grammatically reasonable. Other jurisdictions have abandoned the blue pencil rule for a
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more modern approach which permits the courts to use their equitable powers to enforce a
covenant to the extent reasonable, regardless of severability of clauses or phrases.
New York courts have endorsed the modern approach of modifying a non-compete
agreement where appropriate. See, e.g., Ashland Mgt. Inc. v. Altair Investments NA LLC, 59
A.D.3d 97, 105 (1st Dep’t 2008) (lack of duration limit did not render restrictive covenant
unenforceable because court could modify restriction “to one more reasonable under the
circumstances”); Karpinski v. Ingrasci, 28 N.Y.2d 45, 320 N.Y.S.2d 1 (1971) (inserting a
geographic limitation in a non-compete between a balloon company and a salesperson which was
silent as to geographic area). However, the courts have been cautious in considering
modification and have often declined to modify the contracts where the outcome would be to
drastically alter the original agreement. In EarthWeb, Inc. v. Schlack, the Southern District of
New York declined to re-write an employment agreement because it feared that doing so would
“broaden the sweep of its restrictive covenant.” 71 F. Supp. 2d 299, 311 (S.D.N.Y. 1999). The
court further explained that retroactive alterations can both distort and pervert employment
agreements and also ruin the delicate balance previous courts have tried to maintain when
dealing with non-compete agreements. See Id. In Leon M. Reimer & Co. v. Cipolla, the court
declined to modify a provision requiring that if the accountant solicited business from his former
employer’s clients he had to pay the firm one and a half times the amount the firm collected from
the client annually without geographic limitation. 929 F. Supp. 154, 159-60 (S.D.N.Y. 1996).
The court observed that in order to modify the clause the court would have to rewrite the entire
provision and held that “the infirmities of [the clause] are simply too patent for . . .
restructuring.” Id.; see also Crippen v. United Petroleum Feedstocks, Inc., 245 A.D.2d 152, 666
N.Y.S.2d 156, 156-57 (2d Dep’t 1997) (where term of non-compete period was variable
depending upon the amount of time remaining in the employee’s contract and agreement
contained unspecified geographical restrictions within and outside of the U.S., court held that
agreement was unenforceable since any modification would alter the contract so drastically as to
preclude a finding that plaintiff would have acceded to terms of the contract before signing);
Joint Effort Medical, P.C. v. Dunkelman, 245 A.D.2d 264, 664 N.Y.S.2d 824, 825 (2d Dep’t
1997).
Similarly, in Noonan, Astley & Pearce, Inc. v. Cantor Fitzgerald Sec. Corp., the interdealer broker sought to enjoin several of its former interest rate options brokers from working in
any competitive business within 100 miles of New York. In an unpublished decision, Justice
Cahn declined Noonan’s invitation to modify the covenant and refused to enforce it by a
preliminary injunction. The brokerage firm asked the court to use its equitable power to insert a
provision providing that the brokers would receive their base salary during the restrictive period,
essentially bringing the case in conformity with Maltby. The court declined to include such a
provision because the change would have altered the original agreement too dramatically and the
court concluded the employees would not have likely agreed to the inclusion of the provision
when they signed the agreement. Noonan, Astley & Pearce v. Cantor Fitzgerald Sec. Corp., No.
121168/95 (N.Y. Sup. Ct. N.Y. County Nov. 3, 1995) (Cahn, J.).
More recently, the Southern District of New York declined to modify certain provisions
which it found to be unreasonable due to the “breadth of jobs from which the employee is
forbidden.” See, e.g., Heartland Sec. Corp. v. Gerstenblatt, No. 99 Civ. 3694, 2000 WL 303274,
*9 (S.D.N.Y. Mar. 22, 2000). In Heartland, the Court reiterated that a court may partially
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enforce a restrictive covenant if it finds that the employer was not coercively using its dominant
bargaining power or if the Court finds that the employer was pursuing a legitimate business
interest. Id. Similarly, the Southern District declined to modify a preprinted form contract that
would have prohibited a meeting planner of medical conferences from working with any clients
because it lacked any geographic limits and therefore the employee “could be prohibited from
working anywhere in the world with any agency in the only industry she has known during her
professional career.” AM Medica Communications Group v. Kilgallen, 261 F. Supp. 2d 258,
263 (S.D.N.Y. 2003) (and also noting that “the contract as a whole overreaches”). Thus,
although courts have the authority to modify a non-compete, they have been reluctant to do so if
the modification substantially alters the original agreement. Therefore, in drafting non-compete
agreements, parties should be conservative and should not assume the courts will rehabilitate an
overreaching contract provision.
The leading decision in BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 690 N.Y.S.2d 854
(1999), reconfirms the power and commitment of the New York courts to modify such overbroad
covenants not-to-compete and non-solicitation provisions agreements to make them consistent
with an employer’s legitimate needs for protection of client relations. There, the Court of
Appeals modified a non-compete clause requiring the employee to reimburse an accounting firm
for any clients serviced after his departure so as to cover only those clients with whom he had
direct contact or with whom he had developed goodwill through the expenditure of his
employer’s resources. 93 N.Y.2d at 393, 690 N.Y.S.2d at 862. The court justified this
modification by noting that the agreement was not executed as a condition of employment or
continued employment (thus indicating that the employee was not in an unequal bargaining
position) and because there was no evidence of bad faith or intent to forestall competition on the
part of the employer. Id. A recent example of such a modification is Misys Int’l Banking Sys.,
Inc. v. TwoFour Systems, LLC, No. 650101/2004, 2004 WL 3058144 (N.Y. Sup. Ct. N.Y.
County Nov. 23, 2004), where the court found it inevitable that certain employees of a software
developer would reveal confidential information to their new employer and for other employees
the risk of disclosure was likely. The court, however, modified and enforced the agreements,
reducing the duration of non-compete and non-solicitation agreements from 18 months after
employment termination to 12 months and restricting the unlimited geographic scope of the
agreements to apply only to areas where Misys conducts its international business. Id. The court
granted a preliminary injunction restraining former employees from soliciting former customers
of Misys, using confidential information acquired during their employment with Misys, and
working on the development of specific software that would be a competitor to a product of their
former employer. Id.; Unisource Worldwide, Inc. v. Valenti, 196 F. Supp. 2d 269, 277
(S.D.N.Y. 2002) (reducing geographic reach of noncompete to bring it within scope of
reasonableness). But see Gilman & Ciocia Inc. v. Randello, 55 A.D.3d 871, 872 (2d Dep’t 2008)
(refusing to grant partial enforcement of restrictive covenant where employer could not
demonstrate “the absence of overreaching, the coercive use of dominant bargaining power, or
other anticompetitive misconduct”).
The nature of the employment and the employee’s bargaining position at the time the
restrictive covenant was signed may be factors in determining whether an employer’s conduct is
overreaching or whether the restrictive covenant should be modified. In applying the test from
BDO Seidman to two employees, Justice Friedman, in Creditex, Inc., touches upon this concept.
There, the court compared a more senior broker with an established clientele to an entry-level
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employee. Creditex, Inc. v. Eddy, No. 600755/04 (N.Y. Sup. Ct. N.Y. County, April 16, 2004).
The court modified the non-compete affecting the more senior employee, modifying the
prohibition against any work in the credit derivatives market to a prohibition only against
soliciting any customers he had handled at Creditex. In contrast, the same contract provision
was unenforceable against a broker with one month of experience, and who signed the agreement
before she was hired as an entry-level marketer, because “the employer has not met its burden of
demonstrating ‘an absence of overreaching, coercive use of dominant bargaining power, or other
anti-competitive misconduct.’” Id. (quoting BDO Seidman, 93 N.Y.2d at 394); see also Scott,
Stackrow & Co., C.P.A’s, P.C. v. Skavina, 9 A.D.3d 805 (3d Dep’t 2004) (declining to partially
enforce restrictive covenant where employer, in requiring employee to sign restrictive covenant
as condition to continued employment, made “no showing that, in exchange for her signing the
agreement, defendant enjoyed a fiduciary relationship, a position of increased responsibility
within the firm or any other significant benefit beyond continued employment”; court also noted
that employee was required to sign covenant after issuance of BDO Seidman opinion, which held
similar provision unreasonable); Kanan, Corbin, Schupak & Aronow, Inc. v. FD International,
Ltd., Index No. 603809/04, at 10-11 (N.Y. Sup. Ct., N.Y. County May 9, 2005) (citing Scott,
Stackrow & Co. as partial basis for refusing to enforce restrictive covenants, which defendantemployees were required to sign as condition of initial employment).
New Jersey has also abandoned the “all or nothing” rule in favor of the rule which
permits the court to modify the geographical area, period of enforcement, or scope of prohibited
activities in a non-competition agreement. Solari Indus., Inc. v. Malady, 264 A.2d 53, 61, 55
N.J. 571, 585 (1970). In Solari, an electronics manufacturer sought to enforce a non-competition
covenant against a former executive which prevented the executive from working for a
competitor or contacting any of the employer’s clients. Id. at 54. The court noted that the
agreement was overly broad but held that the agreement could be modified by the court to
prevent the executive from contacting any of the employer’s clients in the United States with
whom the executive had substantial dealings on the employer’s behalf. Id. at 61.
Some states (including Florida and Texas) require by statute that a court modify, rather
than invalidate, an overbroad restrictive covenant. Fla. Stat. § 542.335(1)(c) (“If a contractually
specified restraint is overbroad, overlong, or otherwise not reasonably necessary to protect the
legitimate business interest or interests, a court shall modify the restraint and grant only the relief
reasonably necessary to protect such interest or interests”); see, e.g., Open Magnetic Imaging
Inc. v. Nieves-Garcia, 826 So.2d 415, 418 (Fla. App. 2002) (holding trial court abused discretion
in denying injunctive relief rather than modifying restrictive covenant). V.T.C.A., Bus. & C. §
15.51(c) (if an otherwise enforceable restrictive covenant contains limitations that “are not
reasonable and impose a greater restraint than is necessary to protect the goodwill or other
business interest of the promisee, the court shall reform the covenant to the extent necessary to
cause the limitations contained in the covenant as to time, geographical area, and scope of
activity to be restrained to be reasonable and to impose a restraint that is not greater than
necessary to protect the goodwill or other business interest of the promisee and enforce the
covenant as reformed”); see, e.g., Butler v. Arrow Mirror & Glass, Inc., 51 S.W.3d 787 (Tex.
App. 1st Dist. 2001) (reducing geographic scope of restrictive covenant because §15.51(c)
“imposes a statutory duty on a court to reform a covenant that it finds unreasonable as to time,
geographical area, or scope of activity”).
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As these cases make clear, the extent to which a court will modify or limit the scope of a
restrictive covenant will vary depending on the law of the state governing the agreement.
6.
State Statutes Restricting Non-Competition Covenants
A number of states have enacted statutes governing the enforceability of restrictive
covenants. Some of these statutes merely codify the common-law reasonableness test for
restrictive covenants. See e.g., N.C. Gen. Stat. § 75-2 (covenant must adhere to “principles of
common law”); Wis. Stat. § 103.465 (1996) (restrictions must be “reasonably necessary for the
protection of the employer”). Other statutes limit or purport to limit the enforceability of such
covenants. For example, as discussed at length in Section I.A.2.c. above, Texas has enacted a
statute under which a covenant not to compete may be enforced only “if it is ancillary to or part
of an otherwise enforceable agreement.” Tex. Bus. & Com. Code Ann. § 15.50 (1996).
California has essentially outlawed restrictive covenants in employment contracts except
in situations where the covenant is entered into in connection with the sale of a business. Cal.
Bus & Prof. Code §§ 16600 et seq. (1996) and Cal. Bus. & Prof. Code § 17000 et. seq. (West
1998). Some California courts have recognized an additional “trade secret” exception to § 16600
which permits enforcement of a narrowly drafted restrictive covenant to protect an employer’s
trade secrets. See Asset Mktg. Sys., Inc. v. Gagnon, 542 F.3d 748 (9th Cir. 2008); Bank of
America v. Lee, No. CV 08-5546 CAS, 2008 WL 4351348 at *6 (C.D. Cal. Sept. 22, 2008). The
continued viability of the trade secret exception was recently called into question by an appellate
court decision in California (Dowell v. Biosense Webster, Inc., 102 Cal. Rptr. 3d 1, 10 (Ct. App.
2009)) but was later reaffirmed by several other courts. See Applied Materials, Inc. v. Advanced
Micro-Fabrication Equip. (Shanghai) Co., 630 F. Supp. 2d 1084 n.7 (N.D. Cal. 2009); Majestic
Mktg, Inc. v. Nay, No. E047085, 2010 WL 338966, *5 (Cal. Ct. App. Jan. 29, 2010); Nielsen v.
Platinum Equity, LLC, No. B205605, 2009 WL 2385874, *5 (Cal. Ct. App. Aug 5, 2009).1
Colorado has adopted a statute which voids covenants not to compete unless they are
contained in an agreement relating to (a) the sale of a business or the assets of a business, (b) the
protection of trade secrets, (c) the recovery of education or training expenses of an employee
who leaves an employer after less than two years and (d) executive and management personnel.
Colo. Rev. Stat. § 8-2-113(2) (1996). A recent Court of Appeals decision in Colorado clarified
that the statutory exception applying to executive and management personnel extends beyond
persons who are “in charge” or “act in an unsupervised capacity” to include a “mid-level
manager who supervised fifty employees, was otherwise at the top of the compensation scheme,
was employed in a decision making capacity, and had a certain level of autonomy.” Dish
Network Corp. v. Altomari, 224 P.3d 362 (Col. Ct. App. 2009).
These examples make clear that there are considerable variations in the statutes which
states have enacted governing restrictive covenants. It is therefore imperative that the applicable
state law be checked before any post-employment restrictive covenants are imposed on
employees.
1
The California state court cases reaffirming the trade secret exception are unpublished decisions. California Rule
of Court 8.1115(a) prohibits courts and parties from citing or relying on unpublished opinions.
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B.
Breach of Employment Contract Duration Provision
An employee may also be prohibited from working for a competitor based on language in
a traditional employment agreement, independent of any non-compete agreement or provision.
In American Broadcasting Cos. v. Wolf, 52 N.Y.2d 394 (1981), the court held that where an
employee refuses to render his unique services in violation of an existing contract, an injunction
may be granted to prevent the employee from furnishing those services to another party for the
duration of the contract. Citing this language, a New York court barred an employee from
working for a competitor for the remainder of the contract term in accordance with the
employees’ express agreement not to work for competitors during the employment term.
Wilhelmina Models, Inc., N.Y. L.J., April 16, 1999.
In Wilhelmina Models, the employer sought to enjoin several departing employees from
going to work for competitors based on (a) a provision stating that the employees would not
work for competitors during the contract term and (b) a non-compete provision. The court found
the non-compete agreement unreasonable because it would have prevented the former employees
from working anywhere in New York, New Jersey, Connecticut or California. However,
enforcing the contract provision in which the employees agreed not to work for competitors
during the employment term, the court barred two of the employees from working for
competitors for the remainder of their employment terms, which were four and fourteen months,
respectively. The court went on to state that if the employees sought to return to their jobs,
Wilhelmina was to “make every reasonable effort to accommodate them,” and in the event that
they did not, the employees could move for reconsideration of the court’s decision. A third
employee was not bound by either provision because the court held he had been constructively
discharged.
Practically, once an employee decides to leave to join a competitor, the chances for an
effective reconciliation or continuing employment relationship are slim. The choice to leave
raises serious loyalty issues that may prevent an employer from accommodating a wayward
employee. Where an employer refuses to accept an employee back, equitable considerations
may prevent the use of the term provision to simply put the employee out of work.
C.
“Garden Leave” Provisions
In certain international industries employment arrangements used in other countries have
begun to surface in the United States. One such arrangement is “garden leave.” A “garden
leave” provision is a clause pursuant to which, upon the employee’s notice of termination of the
employment relationship, the employee may be asked to no longer provide services to the
employer, but the employment relationship continues and the employer agrees to pay the
employee his normal salary for the balance of the notice period stated in the contract. Garden
leave is a creature of English law similar to a restrictive covenant in that it is an additional means
of restricting an employer’s ability to join a competitor, but different in that the employment
relationship, with its attendant duties and obligations including fiduciary duties, continues to
exist. Garden leave provisions are routinely used in England and have been used to prevent
employees from working for as much as one year. See John Fellas, Garden Leave: A New
Weapon Against a Departing Employee, N.Y. L.J., May 29, 1997, at 1 (citing Evening Standard
v. Henderson, I.R.L.R. 64 (1987)) (where the contract provided for twelve months’ notice of
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termination, employee who provided two months’ notice was enjoined from joining rival
newspaper). See generally Greg. T. Lembrich, Note: Garden Leave: A Possible Solution to the
Uncertain Enforceability of Restrictive Employment Covenants, 102 Colum. L. Rev. 2291 (Dec.
2002). When used in conjunction with a non-compete covenant, a garden leave provision has the
effect of extending the period during which competitive activity is prohibited; the employee
potentially may not work for a competitor during the balance of the notice period, and for an
additional period under the non-compete provisions. This two-pronged approach has been
upheld by English courts. Credit Suisse Asset Mgmt. v. Armstrong, I.R.L.R. 450 (1996)
(holding that a garden leave clause and a non-compete clause may coexist and be equally
enforceable but noting that the existence of a garden leave clause would be a factor taken into
account in determining the enforceability of the restrictive covenant).
Several U.S. courts have recognized the enforceability of a garden leave clause. See e.g.,
Deutsche Bank Sec. Inc. v. Zelnick, Index No. 10/600986 (N.Y. Sup. Ct., Apr. 2010) (Fried, J.)
(granting TRO enforcing garden leave notice period to prevent employees from working for a
competitor and requiring former employer to allow the employees back during garden leave
period to service clients if they choose to return); Cantor Fitzgerald L.P. v. Chandler, No. 15689,
1998 WL 442440 (Del. Ch. July 20, 1998) (recognizing British court’s decision granting plaintiff
injunctive relief pursuant to garden leave provision and holding that plaintiffs waived their right
to adjudicate claims for damages arising prior to enforcement of the garden leave provision, but
not as to damages sustained after the garden leave period). The decision in Chandler suggests
that enforcement of both a non-compete clause and garden leave clause may not be inequitable.
There, the employer was permitted to enforce a garden leave provision and seek damages for
breach of the employment agreement and duty of loyalty during the period after garden leave.
Chandler, 1998 WL 442440, at *22. This indicates that a garden leave provision may be
enforceable independent of and in addition to other provisions in an employment contract.
In New York, a thirty (30) day period of a notice of termination provision was tacked to a
ninety (90) day period of a non-compete clause in an order granting a preliminary injunction in
Natsource LLC v. Paribello, 151 F. Supp. 2d 465 (S.D.N.Y. 2001). More recently, Credit Suisse
failed in its attempt to enforce a thirty (30) day notice period provision to prevent an employee
from joining a competitor. Credit Suisse Securities (USA) LLC v. Ebling, 06 Civ. 11339, 2006
WL 3457693 (S.D.N.Y. Nov. 27, 2006). The court enforced a non-solicitation of clients clause
in the contract, but observed that the employee had already commenced employment with a
competitor, and that Credit Suisse failed to show irreparable harm absent an injunction barring
employment with the competitor.
While there is some case law indicating that garden leave provisions may be enforceable
in Delaware and New York, courts in Massachusetts and Georgia have recently declined to
enforce garden leave clauses. See Bear, Stearns & Co. Inc. v. Sharon, 550 F. Supp. 2d 174 (D.
Mass. 2008) (garden leave provision contrary to public policy because it would require employee
to continue employment against will and would cause hardship to clients); Bear, Stearns & Co.
Inc. v. McCarron, Civ. No. 08-0979-BLS-1 (Mass. Super. Ct. Suffolk County March 5, 2008)
(garden leave provision not enforceable because unfair to clients). A Georgia court also denied
an application to enforce a notice provision to prevent an employee from joining a competitor,
and concluded that a garden leave provision may merit scrutiny like a non-compete provision.
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Carvalho v. Credit Suisse Sec., LLC, Civ. Action No. 1:07-CV-2612, RSW, U.S. D.Ct. N. D. Ga,
October 31, 2007).
These opinions demonstrate that courts in U.S. jurisdictions may apply the same general
criteria to the restrictions at issue in garden leave provisions as they do in other post-employment
restrictions and, to the extent additive restraints are too burdensome, will limit them accordingly.
D.
Non-Solicitation Provisions
Employment agreements may contain provisions precluding the employee from soliciting
clients or other employees of the employer to discontinue or diminish their relationship with the
employer, in lieu of or in addition to pure covenants Not-to-Compete. With regard to solicitation
of clients, the provisions must be reasonable in scope and no broader than necessary to protect
the employer’s legitimate interests. See, e.g., Lawrence and Allen v. Cambridge Human
Resource Group., Inc., 685 N.E.2d 434, 441 (Ill. App. Ct. 1997) (noting that courts are hesitant
to enforce prohibitions against employees servicing not only customers with whom they had
direct contact, but also customers they never solicited or had contact with while employed);
Mallory Factor, Inc. v. Schwartz, 146 A.D.2d 465, 536 N.Y.S.2d 752 (1st Dep’t 1989)
(upholding a non-solicitation clause prohibiting an employee from working with any customers
with whom he had been involved during the term of his employment); Arpac Corp. v. Murray,
589 N.E.2d 640, 649 (Ill. App. Ct. 1992) (affirming enforcement of a non-solicitation clause
prohibiting employee from working with any customers with whom he had worked during the
preceding five years); Mgmt. Recruiters of Boulder, Inc. v. Miller, 762 P.2d 763, 766 (Colo. Ct.
App. 1988) (upholding portion of non-solicitation clause prohibiting contact with customers with
whom the employee had actual contact, but not those to whom he merely had access). But see
McFarland v. Schneider, 11 Mass. L. Rep. 711, 1998 WL 136133 (Mass. Super. Ct. 1998)
(upholding non-solicitation clause providing for five-year ban on providing services to all clients
of the investment company citing the need to maintain the investment company’s internal morale
and external goodwill). As indicated earlier, one-year non-solicitation provisions contained in
Merrill Lynch broker contracts have routinely been enforced. See Section 4(b), supra.
Non-solicitation agreements may not be enforceable to the extent they prevent an
employee from communicating with clients or contacts which were acquired by the employee
prior to employment or through the employee’s own efforts. A recent decision applying Florida
law held that an employer could not enforce a restrictive covenant that would preclude the
employee from using contacts gained prior to his employment with the company. GPS Indus.,
LLC v. Lewis, 691 F. Supp. 2d 1327 (M.D. Fla. March 1, 2010). Courts in Illinois and
Massachusetts have reached similar conclusions. See Com-Co Ins. Agency, Inc. v. Service Ins.
Agency, Inc., 321 Ill.App.3d 816, 820–21 (2001). Cf. Smith Barney Div. of Citigroup Global
Markets, Inc. v. Griffin, No. 08-0022, 2008 WL 325269, at *4 (Mass. Super. Jan. 23, 2008)
(stating that an employer “may preserve [] its own goodwill, not the goodwill earned by the
employee that fairly belongs to the employee” (citing Sentry Ins. v. Firnstein, 14 Mass.App.Ct.
706, 708 (1982))); Getman v. USI Holdings Corp., No. 05-3286, 2005 WL 2183159, at *3
(Mass. Super. Sept. 1, 2005) (same); Liberty Mut. Ins. Co. v. Batchelor, No. 09-4170, 2009 WL
5910242 (Mass. Super. Ct. Middlesex County Nov. 23, 2009).
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In New York, the Court of Appeals explained the extent to which an employer may
enforce a non-solicitation provision against a former employee in BDO Seidman v. Hirshberg.
There, the defendant executed a “Manager’s Agreement,” which provided in part that if he left
BDO’s employ and served any former client of BDO, he would compensate the company at a
rate of one and one-half times the amount of fees charged to that client by BDO over the last
fiscal year. The court declined to enforce the non-solicit clause as written, finding that while the
employer had a legitimate interest in protecting customer relationships acquired during the
course of employment, the clause was more restrictive than necessary to protect that interest. 93
N.Y.2d at 391. The court reasoned that the defendant would be penalized for soliciting any
former BDO clients, whether or not he had developed relationships with them while performing
“direct and substantial accounting services” on behalf of BDO. The court held that the clause
was unenforceable to the extent that it required the defendant to compensate BDO for clients
with whom he had never acquired a relationship. However, the Court of Appeals reaffirmed the
lower New York courts’ long-standing commitment to modifying such agreements to the extent
necessary to provide the necessary level of protection for employers and went on to narrow the
clause to cover only clients developed “through the direct provision of substantive accounting
services during his employment”; clients with whom he had no such relationship and personal
clients developed through the defendant’s own recruitment efforts before he joined the firm
would not be covered. Id. at 393; accord Scott, Stackrow & Co., C.P.A’s, P.C. v. Skavina, 9
A.D.3d 805 (3d Dep’t 2004) (“A covenant will be rejected as overly broad . . . if it seeks to bar
the employee from soliciting or providing services to clients with whom the employee never
acquired a relationship through his or her employment or if the covenant extends to personal
clients recruited through the employee's independent efforts.”) (4th Dep’t 2004); Kanan, Corbin,
Schupak & Aronow v. FD Int’l, Ltd., 8 Misc.3d 412 (Sup. Ct. N.Y. Co. 2005) (employer failed
to make required minimal showing that goodwill allegedly misappropriated was created at
employer’s expense as opposed to employee’s own making, thus warranting denial of
injunction); Milbrandt & Co., Inc. v. Griffin, 798 N.Y.S.2d 711, 2004 N.Y. Slip. Op. 51333(U)
(N.Y. Sup. Ct. Oct. 7, 2004) (denying summary judgment to employee, as triable issues of fact
remained concerning whether goodwill was generated and maintained at employer’s expense, or
whether they were developed “only as a result of defendant’s own independent efforts, which
were neither subsidized nor otherwise financially supported by the agency”).
Agreements that purport to limit a former employee’s right to communicate with
prospective customers of the employer have historically been deemed unenforceable in New
York. See, e.g., Jay’s Custom Stringing, Inc. v. Yu, No. 01 Civ. 1690 (WHP), 2001 WL 761067,
*7 (S.D.N.Y. 2001) (denying enforcement where the provision precluded the employee, a tennis
racket expert, from soliciting the business of any client or prospective client of the employer.
The court found the provision overly restrictive as “the definition of a prospective client appears
to include any professional tennis player”); Ivy Mar Co. v. C.R. Seasons, 907 F. Supp. 547, 559
(E.D.N.Y. 1995) (holding that restriction that extended to prospective customers was
unenforceable as a matter of law); Webcraft Technologies, Inc. v. McCaw, 674 F. Supp. 1039,
1047 (S.D.N.Y. 1987) (injunction could not extend to “potential” purchasers with whom
employee had no contact and as to whom she acquired no information while employed by
plaintiff company). But see Loewen Group Int’l, Inc. v. Haberichter, 165 F.3d 32 (7th Cir. 1998)
(given “near-permanent” nature of relationships, non-solicitation clause barring former funeral
home manager from soliciting customers “within a 10-mile radius of the present location of
Chapel” included all potential customers within the territory, not simply immediate family of
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former customers and those with “preneed” contracts). Despite this earlier case law, several
courts in New York have recently enforced restrictive covenants prohibiting former employees
from soliciting prospective clients of their former employer. See, e.g., Kelly v. Evolution
Markets, Inc., 626 F. Supp. 2d 364, 377 (S.D.N.Y. 2009); U.S. Trust Co., NA v. Maclachlan, No.
0602908, 2008 WL 168967, *1 (Sup. Ct. N.Y. County Jan. 3, 2008). The MacLachlan court
limited the prohibition on the solicitation of prospective clients to those clients with whom the
employee had dealt during the course of their employment.
Thus, as is the case with non-compete provisions, New York courts will inquire into the
reasonableness of a restriction on solicitation, and for non-solicitation clause purposes, into the
history of the customer relationships.
E.
Non-Acceptance Provisions
Some employment agreements include provisions which seek to prevent an employee
from servicing or accepting business from a client of their former employer after employment
ends, even where they have not solicited such business. Courts tend to analyze these non-service
or non-acceptance provisions as covenants Not-to-Compete, which must be reasonable in terms
of the restraint on trade imposed and for the purpose of protecting legitimate business interests.
See Leon M. Reimer & Co., P.C. v. Cipolla, 929 F. Supp. 154, 157 (S.D.N.Y. 1996); see also
Rhoads v. Clifton, Gunderson & Co., 89 Ill. App. 3d 751, 411 N.E.2d 1380 (Ill. App. Ct. 1980);
Foti v. Cook, 220 Va. 800, 263 S.E.2d 430 (1980). Refer to Part I.A. for a thorough discussion
of covenants Not-to-Compete.
A federal court applying New York law recently confirmed that New York will enforce a
provision precluding an employee from accepting business from a former client if such a
provision is otherwise reasonable and necessary to protect the employer’s legitimate interest.
Marsh USA Inc. v. Karasaki, No. 08 Civ. 4195 (JGK), 2008 WL 4778239, *18 (S.D.N.Y. 2008).
Marsh involved an insurance professional and relied primarily on the seminal decision of the
Court of Appeals in BDO Seidman v. Hershberg, 93 N.Y.2d 382 (1999) to reach this conclusion.
The clause in Marsh required the employee not to “perform or supervise the performance of
services or provision of products of the type sold or provided by the employee while he or she
was employed by the company on behalf of any clients or prospective clients of the company.”
In Marsh the court stated “. . . numerous courts that have considered restrictive covenants
prohibiting the servicing of an employee’s former clients have found them to be enforceable, so
long as they are otherwise reasonable in scope. BDO Seidman dealt precisely with a nonservicing provision … ”.
In BDO the issue before the court on a motion for summary judgment was whether a socalled “reimbursement clause” in an accountant’s employment agreement with his former
employer was enforceable. The clause required the accountant to compensate his former
employer if he served any client of the accounting firm’s Buffalo office in the 18 month period
following the termination of his employment with the firm. The court concluded that the clause
was essentially a non-compete clause and conducted an inquiry into the reasonableness of the
clause. While the court found the clause to be overbroad, particularly to the extent it prevented
the accountant from doing business with BDO clients he had no relationship with, it
nevertheless granted partial summary judgment to the former employer on liability with regard to
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business with certain BDO clients. The court remanded for further proceedings on the issue of
damages.
There are a few recent instances in which lower New York courts have declined to
enforce provisions preventing employees from servicing clients of their former employer in the
financial services industry at the preliminary injunction stage. In these cases the courts were
persuaded to find the clauses unenforceable based on FINRA rules and policies designed to
prevent FINRA members and associated persons from interfering in a client’s choice of
investment professional.2 In First Empire Securities, Inc. v. Miele, 17 Misc. 3d 1108(A), 2007
WL 2894245, *4 (N.Y. Sup. Ct. Suffolk County Aug. 10, 2007) the court observed that the
“[FINRA] Rules do not permit business entities and individuals governed by those rules to
restrict customers from freely choosing the person or entity with which they wish to do
business.” The court declined to issue an injunction preventing the employee from accepting
business from clients who were not solicited by the employee finding that “to the extent that the
restrictive covenant signed by the [employee] attempts to prevent the [employee] from taking
orders from former clients who contact him without solicitation by the [employee], it is not
reasonable.” Id.
Similarly, in U.S. Trust Co. N.A. v. MacLachlan, No. 0602908, 2008 WL 168967 (N.Y.
Sup. Ct. N.Y. County Jan. 3, 2008) the court held that a FINRA registered broker could not be
“enjoined from accepting business from U.S. Trust’s clients or prospective clients with whom
she had dealt that initiate contact with her voluntarily and unsolicited.” According to the court,
“[a] restraint of that nature would be unduly burdensome on the defendant and injure the public
by preventing investors from freely choosing the financial advisor with whom they wish to
entrust their assets.” Maclachlan, 2008 WL 168967 at *6; see also Deloitte & Touche LLP v.
Chiampou, 222 A.D.2d 1026, 636 N.Y.S.2d 679 (4th Dep’t 1995) (finding a preliminary
injunction enforcing a covenant Not-to-Compete proper where it exempted “plaintiff’s former
clients who had voluntarily and without solicitation sought out defendants after defendants left
plaintiff's employ”); AM Medica Communications Group v. Kilgallen, 261 F. Supp. 2d 258, 263
(S.D.N.Y. 2003) (finding a two-year non-service provision unenforceable because plaintiff had
2
FINRA Rule 2140 provides that
No member or person associated with a member shall interfere with a customer's request to
transfer his or her account in connection with the change in employment of the customer's
registered representative where the account is not subject to any lien for monies owed by the
customer or other bona fide claim. Prohibited interference includes, but is not limited to, seeking a
judicial order or decree that would bar or restrict the submission, delivery or acceptance of a
written request from a customer to transfer his or her account.
Under this rule, FINRA member firms may be unable to enforce a non-acceptance provision in a restrictive
covenant. At least one New York court has reached this conclusion. See e.g., First Empire Securities, Inc. v. Miele,
17 Misc. 3d 1108(A), 2007 WL 2894245 (N.Y. Sup. Ct. Suffolk County Aug. 10, 2007). In Salomon Smith Barney,
Inc. v. Barcomb, No. 02-5484 BLS, 2002 WL 31957010 (Mass. Super. Ct. Dec. 10, 2002), the court referenced this
rule in the context of former clients being provided with account transfer forms to follow the defendant to his new
place of employment. The implication appears to be that, while providing such forms to former clients is
impermissible conduct, the clients may still transfer their accounts because the customers “are wholly innocent in
this shuffle of their representative from one brokerage house to another.” Id. at *2.
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failed to sufficiently demonstrate how employee’s work for a competitor would jeopardize its
business interests or that employee was privy to relevant confidential information).
These two state cases both involve employees who were registered representatives; First
Empire was actually a petition for an injunction in aid of a FINRA arbitration. Neither case
addresses the question of whether an ex-employer may assert a claim for damages (rather than
seek the equitable relief of an injunction) against an employee who has breached a contractual
provision prohibiting the employee from doing business with an ex-employer’s clients. At least
one New York court has held that this distinction makes a difference. See Kanan, Corbin,
Schupak & Aronow v. FD Int’l, Ltd., 8 Misc.3d 412 (Sup. Ct. N.Y. Co. 2005) (“Specific
enforcement [of restrictive covenants] in the context of the Seidman case was payment of
liquidated damages and did not involve the considerations a court must make when
contemplating the ‘drastic remedy’ of preliminary injunction”); but see Leon M. Reimer & Co.,
P.C. v. Cipolla, 929 F. Supp. 154, 157 (S.D.N.Y. 1996) (granting summary judgment in favor of
employee and finding clause unenforceable which required accountant to reimburse former
employer, an accounting firm, for “one and one half times the annual gross fees” the former
employer earned from the client during the last full year client was serviced by former employer
because restriction was overprotective of employer’s interests, imposed an unreasonable
limitation on employee and the former employer’s clients’ choice in professional services and
was an unenforceable penalty clause).
Massachusetts law on the enforceability of non-acceptance provisions is somewhat
unsettled. In a recent decision, a Massachusetts court refused to enforce a non-servicing
provision as an unenforceable restraint on trade. Mazonson Inc. v. Greenbaum, No. 071327,
2007 WL 1829390 (Mass. Super. Ct. Middlesex County May 4, 2007). In contrast, in American
Express Financial Advisors Inc. v. Walker, 9 Mass. L. Rep. 242, 1998 WL 754620, n.9 (Mass.
Super. Ct. Oct. 28, 1998), the Superior Court of Massachusetts found reasonable a one-year ban
on solicitation of former clients and a four month ban on acceptance of business from former
clients. The court found that a four-month prohibition on acceptance of business from former
clients was a reasonable amount of time because (a) barring the financial advisor only from
solicitation would give inadequate protection to American Express’ goodwill, and (b) while it
may not be difficult to identify aggressive solicitation, it is quite difficult to identify and sanction
more subtle forms of it. Thus, the court reasoned, “a four month period in which the financial
advisor is barred from accepting the former client’s business at least means that, if a client
chooses to stay with the financial advisor, he will do so only after four months have passed from
the communication informing him of his advisor’s departure from American Express. By then,
not only will American Express have had the opportunity to establish a relationship between the
client and a new financial advisor but any subtle solicitation done at the time of departure will be
four months old and likely forgotten.” Id. A Massachusetts court enforced a five-year
prohibition on acceptance of business from former clients in McFarland v. Schneider, No. CA
96-7097, 1998 Mass. Super. LEXIS 711 (Mass. Super. Ct. Feb. 17, 1998). Wellington
Management Company, an investment advisory partnership, sought to enforce a restrictive
covenant provision in the partnership agreement against Mr. Schneider, a former partner with the
company, that prevented a partner for a period of five years after termination from conducting
any business for a client of Wellington. The court rejected Mr. Schneider’s argument that clients
have a right to choose their portfolio manager, noting that there is no shortage of talented
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portfolio managers and since Wellington’s contracts provide for termination on 30 days notice, a
client may not thereafter choose the portfolio manager at Wellington if this option is elected.
F.
Confidentiality Provisions
Though the common law imposes a duty on an employee to maintain the confidences of
its employer, confidentiality provisions are common in employment agreements. They serve the
useful purpose of defining what the employer considers to be proprietary and what the employee
should understand cannot be disclosed to outsiders. Where disputes arise over whether other
contractual provisions are necessary to protect an employer’s legitimate interests, confidentiality
provisions can offer a glimpse of the parties’ respective state of mind concerning what can and
what should not be disclosed. They can also be persuasive in considering whether equitable
relief may be appropriate to prevent the misuse of customer-related information. U.S. Trust
Corporation v. Cowperthwait Partners LLC, supra (granting restraining order and three-month
preliminary injunction restraining solicitation of clients and misuse of confidential information
where defendants were subject to confidentiality agreements, but no covenants not-to-compete or
non-solicitation provisions).
In particular, courts have recognized that solicitation of a former employer’s clients based
on casual memory is impermissible where there is a confidentiality agreement which expressly
protects the former employer’s client lists. See North Atlantic Instruments, Inc. v. Haber, 188
F.3d 38, 47 (2d Cir. 1999); see also Ashland Mgmt. Inc. v. Altair Investments NA, LLC, 59
A.D.3d 97 (1st Dep’t 2008) (“[I]f the parties entered into a confidentiality agreement and the
proprietary information at issues constitutes a trade secret, whether the defendants’ use of that
information was a result of casual memory is irrelevant.”); Kadant, Inc. v. Seeley Machine, Inc.,
244 F. Supp. 2d 19, 37 n.10 (N.D.N.Y. 2003); compare Panther Systems II, Ltd. v. Panther
Computer Systems, Inc., 783 F. Supp. 53, 67 (E.D.N.Y. 1991) (“[S]olicitation of plaintiff's
customers as a product of defendants’ casual memory is permissible, given the absence of a
restrictive covenant.”) (emphasis added). Thus, confidentiality provisions serve to clarify the
rights and obligations of the parties involved, and may serve to refute a casual memory defense.
G.
Intra-Competitor No Poach Agreements
While the case law discussing employer-employee non-competition agreements is well
developed, there are few reported cases discussing employer-employer non-competition
agreements. These employer-employer agreements, often referred to as “no-poach”, “no-hire” or
“no-switching” agreements, prohibit signatories from soliciting or “pirating” employees of other
signatories or from hiring former employees of other signatories for a specified period of time.
These agreements may have implications under federal antitrust laws at least insofar as they
affect employees who are not bound by employment contracts containing non-compete clauses.
Where the parties to the agreement are competitors in dominant positions within the industry,3 in
3
Where the agreements involve entities not necessarily in competition with one another (e.g. franchisor
and franchisee or members of a corporate family), courts have dismissed Sherman Act claims. See, e.g.,
Thomsen v. Western Electric Co., 680 F.2d 1263 (9th Cir. 1982) (agreement among AT&T and its
subsidiaries that prohibited parties from hiring former employees of the other subsidiaries without a
signed release did not constitute a restraint of trade); see also Lisa Hamm-Greenawalt, Amazon, Wal-Mart
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some cases agreements affecting non-contractual employees have been struck down as violations
of federal antitrust law (or challenges to such agreements have at least survived motions to
dismiss for failure to state a claim or for summary judgment). See Union Circulation Co. v.
Federal Trade Commission, 241 F.2d 652 (2d Cir. 1957); Nichols v. Spencer International Press
Inc., 371 F.2d 332 (7th Cir. 1967); Quinonez v. National Association of Securities Dealers, 540
F.2d 824 (5th Cir. 1976).
Union Circulation involved a no-poach agreement among magazine subscription agencies
that prohibited signatories from hiring non-contractual employees who had been employed by
other participating agencies, and in some cases by non-signatory agencies, during the past year.
The Federal Trade Commission enjoined the agencies from carrying out the agreement finding
that it constituted an unreasonable restraint of trade and unfair competition in violation of the
Sherman Antitrust Act. 241 F.2d at 655. The Second Circuit held that the agreement was not
invalid per se, but given that the agreement operated to discourage labor mobility, it had an
actual and potential impact on the competitive structure of the magazine-selling industry and was
therefore an unreasonable restraint of trade in violation of the Sherman Act. Id. at 658.
In Nichols, publishers of encyclopedias entered into an agreement that prohibited each
from hiring former non-contractual employees of the other signatories for a six-week period
following termination of their employment with the previous employer. Plaintiff, a salesman
who was discharged as a result of pressure to comply with the no-switching agreement, brought
suit claiming a violation of the Clayton Act and the Sherman Act. The court held that as a
general matter, one who is damaged by loss of employment as a result of a violation of the
antitrust laws is injured in his business or property and is entitled to recovery under the antitrust
laws. 371 F.2d at 334. However, in the case of no-switching agreements, a court must consider
whether the agreements impair full and free competition in the supply of services and
commodities to the public, and the degree to which they do so. Id. at 337. The court went on to
hold that summary judgment in favor of the employers was inappropriate without further inquiry
into the impact on the industry and the reasonableness of the agreement. Id.
In Quinonez, securities dealers entered into an agreement prohibiting each from hiring
any person who had been rejected for employment or discharged by one of the signatories.
Plaintiff, a salesman who was discharged soon after being hired by one of the signatories, sued
claiming violation of the Sherman Act and the Clayton Act. The district court dismissed the
claim for failure to state a cause of action. The Fifth Circuit held that the complaint which
alleged “a blocking of interchange among employees of the securities industry and synergetic
threats of business boycott” stated a claim for relief under the Sherman Act and the Clayton Act.
540 F.2d at 828-30.
Complaints that do not allege an impairment of competition or effect on trade and
commerce may not survive motions to dismiss for failure to state a claim. In Taterka v.
Wisconsin Telephone Co., 394 F. Supp. 862 (E.D. Wis. 1975), aff’d, 559 F.2d 1224 (7th Cir.
Agreement Puts Net Firms On Notice About Hiring Away Blocks of Talent, Mecklermedia Corporation,
Internet World, April 19, 1999 (discussing April 1999 settlement in which Amazon agreed not to recruit
Wal-Mart employees but would be permitted to hire those that approach it).
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1977), plaintiff alleged a violation of the Sherman Act based on an agreement among telephone
companies not to hire former employees of participating companies for a period of six-months
after termination. The court held that the complaint did not state a cause of action because
plaintiff failed to allege that competition was impaired or that a contract or conspiracy
arrangement existed between the parties. Id. at 865.
In addition, courts have struck down “no-switching” agreements based on state laws. For
example, in Dyson Conveyor Maintenance, Inc. v. Young & Vann Supply Co., 529 So. 2d 212
(Ala. 1988), the court struck down an agreement between two companies to refrain from
soliciting non-contractual employees of the other as a violation of the Alabama statute
prohibiting restraint in the exercise of one’s profession, trade or business. Id. at 215. Notably,
the court emphasized that agreements between competitors may survive state and federal law
challenges to the extent that they supplement employer/employee contracts. Id. Dyson,
however, was explicitly overruled by Crown Castle USA, Inc. v. Howell Engineering and
Surveying Inc., 981 So.2d 413 (Ala. 2006) in which a no-hire agreement between competitors
was found to be valid under Alabama state law even though the employee was not subject to a
corollary non-compete agreement. The court found that “the no-hire provision…did not prevent
[the employee] from practicing her trade or profession. Because the only employer for whom
she was prohibited from working was Crown Castle, she clearly continued to have an
opportunity for meaningful employment.” Crown Castle, 981 So.2d at 423.
Other courts have also upheld “no-switching” agreements based on state law. See, e.g.,
Freund v. E.D. & F. Man International, Inc., 199 F.3d 382, 385 (7th Cir. 1999) (opining that
“[w]e infer that under Illinois law an employer who has made a substantial investment in the
human capital of its employees to enforce a covenant by his employees Not-to-Compete with
him . . . can also enforce a promise by another employer not to hire away these employees.”);
Haines v. VeriMed Healthcare Network, LLC, (E.D. Mo. 2009) (finding provision prohibiting
web-content provider from using the services of any independent contractor of website
owner/operator did not violate federal or state anti-trust laws). Of course, the Court of Appeals
in Freund maintained that these agreements were subject to the usual geographic and temporal
requirements of reasonableness. Id.
Courts have been reluctant to find that “no-hire, no-poach” agreements are per se illegal.
The Third Circuit in Eichorn v. AT&T Corp., 248 F.3d 131, 143 (3d Cir. 2001), held that a nohire agreement executed pursuant to the sale of a corporation was subject to a rule of reason
analysis under the anti-trust laws and was not per se illegal. In Eichorn, a parent corporation had
sold an affiliate to another company and entered into an agreement not to hire any of its
employees for eight months following the sale. Employees of the affiliate sued, claiming the nohire agreement violated the Sherman Act and ERISA (because the no-hire agreement effectively
canceled their bridging rights under their pensions). The court stated that it found no support for
the plaintiffs’ position in the relevant case law that no-hire agreements are per se illegal and that
the only two federal courts that had addressed the issue as it pertained to the sale of a business
found that the rule of reason test applied. See Coleman v. General Elec. Co., 643 F. Supp. 1229
(E.D. Tenn. 1986), aff’d, 822 F.2d 59 (6th Cir. 1987); Cesnick v. Chrysler Corp., 490 F. Supp.
859 (M.D. Tenn. 1980). The court went on to find the restriction reasonable under the Sherman
Act, but remanded the ERISA claim.
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More recently, in Global Telesystems, Inc. v. KPNQwest, 151 F. Supp. 2d 478 (S.D.N.Y.
2001), the court granted a preliminary injunction in favor of a plaintiff seeking to enforce a nosolicitation/no-hire provision contained in a confidentiality agreement between two competing
telecommunications companies. The no-solicitation provision applied for an 18-month period.
When an employee who had been a senior vice president of the plaintiff and chief financial
officer of the plaintiff’s subsidiary was hired by the defendant, the plaintiff sued for breach of the
agreement. While the court did not discuss the general legality of such agreements, it did note
that the defendant had derived substantial benefit from the confidentiality agreement and could
not argue that parts of the agreement were unenforceable or not binding. Id. at 483.
To summarize, agreements that affect non-contractual employees may be subject to
federal antitrust claims to the extent that (a) the parties are dominant in the industry (or a
segment of the industry) and (b) their agreement could operate to affect the competitive structure
of the industry. In contrast, agreements that restrict the ability to interfere with the employment
relations of contractual employees do not raise the same restraint of trade concerns and are
therefore unlikely to face federal and state antitrust challenges.
II.
Damages
While traditionally courts have calculated damages for an employee’s breach of contract
as the difference between the agreed upon contract price and the amount required to obtain these
same services from another person available for replacement, this does not apply where the
services of an employee is of a unique character such that it is difficult to replace them. See
Valentine Dolls, Inc. v. McMillan, 25 Misc. 2d 551, 202 N.Y.S.2d 620 (N.Y. Sup. Ct. 1960).
Thus, lost profits may be an appropriate measure of damages where unique customer
relationships are at issue. Where employment agreements contain “buy-out” provisions
calculating the amount which must be paid as a result of early termination, the provision will
ordinarily be enforced as the measure of contract damages. See RMJ Sec. Corp. v. Kirwin, No.
128162/94, (N.Y. Sup. Ct. Jan. 8, 1997); BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 690
N.Y.S.2d 854 (1999) (enforcing clause requiring employee to reimburse accounting firm for any
clients serviced after his departure at the rate of one and one-half times the fees charged to the
client over the last fiscal year, but only as to clients with whom he had direct contact or
developed goodwill as a result of employer’s subsidy); GFI Brokers, LLC v. Santana, Nos. 06
Civ. 3988, 06 Civ. 4611 (S.D.N.Y. Aug. 13, 2009) (upholding a liquidated damages provision in
an employment agreement that required former employee of broker-dealer to pay, in the event of
a breach of a non-competition or non-solicitation clause, damages based on the monthly average
of that former employee’s revenues for the 12-month period before his departure from his former
employer); Weber, Lipshie & Co. v. Christian, 52 Cal. App. 4th 645, 60 Cal. Rptr. 2d 677 (Cal.
Ct. App. 1997) (upholding a liquidated damages provision in a non-compete agreement that
required a former partner of an accounting firm to pay damages calculated by doubling the firm’s
time charges for clients lost due to the breach for the twelve-month period immediately
preceding the loss); Barbe v. A.A. Harmon & Co., 705 So. 2d 1210 (La. Ct. App. 1998) (a
non-compete agreement that prevented an invalidating departing partner of an accounting firm
from performing any accounting or tax work from any client of the firm at the time of his
departure for two years when the agreement required the partner to pay the firm upwards of 200
percent of the fee he received from the client).
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Invaluable contributions to this Overview were provided by Carter Ledyard & Milburn
LLP associate Emily Milligan and other members of the firm's legal staff.
For further information please contact any of the following:
Carter Ledyard & Milburn LLP
Two Wall Street
New York, New York 10005
(212) 732-3200 (telephone)
(212) 732-3232 (fax)
Lawrence F. Carnevale
(212) 238-8617 (direct)
E-mail: [email protected]
Emily Milligan
(212) 238-8628(direct)
Email: [email protected]
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