Restrictive Covenants Case Law Update

Thursday, January 1, 2009 - 01:00

The downturn in the economy has created an increase in restrictive covenant litigation as employers seek to prevent competitors from gaining access to their confidential and proprietary information, clients and employees. We present below a summary of the principles and issues concerning non-compete and non-solicitation provisions that have been addressed by state and federal courts within New York State in the last year and discuss representative cases.

The cases summarized below do not break new ground; rather, they are generally consistent with well-established New York law regarding restrictive covenants, including:

• Courts remain more willing to enforce non-solicitation restrictions than non-competition restrictions.

• An employer should think long and hard prior to initiating what is likely to be a costly and burdensome restrictive covenant case: what business need is the employer trying to protect? For instance, (i) are the departing employee's services unique or extraordinary and (ii) is enforcement necessary to prevent misuse of the employer's trade secrets or confidential information?

• If the employer determines that there is a business need worth trying to protect, can it prove this need with evidence?

• Employers lose employees to their competitors; they also recruit employees from their competitors. As a result, it is possible that an employer may find itself on both sides of restrictive covenant cases - seeking to defeat restrictions in the latter and uphold them in the former. Accordingly, employers need to think carefully about the statements they make in court papers, as such arguments may be quoted against them in subsequent litigation when they are on the other side of the argument - especially now that papers are widely available electronically.

• All potential defendants are not created equal. A court is more willing to enforce restrictive covenants against more educated and well compensated employees.

• Did the former employee commit any wrongdoing - other than breaching his or her restrictive covenants - at or around the time his or her employment terminated ( e.g. , deleting or printing e-mails or stealing documents)? Courts remain more willing to enforce restrictive covenants against such employees.

• Whose client relationship is it? Courts remain hesitant to enforce non-solicitation of client restrictions against employees who had done business with clients prior to joining their employer or who did not have any relationship with the clients during their employment.

Non-Compete Restrictions Enforced

When a court finds that a restriction is reasonable in time and geographic scope, based on a legitimate business need, and no more restrictive than necessary, it will likely enforce that restriction.

Payment Alliance Int'l, Inc. v. Ferreira , 530 F.Supp. 2d 477 (S.D.N.Y. 2007): Executive enjoined for a period of two years from working for a direct competitor in continental United States because his former employer had merchant customers in every state in the continental United States, notwithstanding that he would not be paid his salary during the non-compete period; employee was knowledgeable about employer's new and secret software application and new job in similar capacity with direct competitor created risk that disclosure of trade secrets was inevitable.

Further, courts continue to modify restrictions they find inconsistent with the employer's legitimate business needs.

Good Energy v. Kosachuk , 49 A.D.3d 331, 853 N.Y.S.2d 75 (1st Dep't 2008): Non-compete covenant banning former employee from dealing with employer's entire client base anywhere in the United States was deemed unreasonable, but restriction was modified to (i) limit covered territory to the eight states in which employer operated and (ii) eliminate restriction against dealing with those clients that were not serviced by the employee during his employment and those clients that came to employer solely because of preexisting relationship with employee.

Non-Compete Restrictions Not Enforced

Courts refuse to enforce non-compete obligations where the former employer fails to show a legitimate business need for the covenant as written; even where the time and geographical scope of the restriction are reasonable, the court will reject enforcement of the restriction if the employer has no legitimate business need for it.

Boston Laser, Inc. v. Zu , 2007 WL 2973663 (N.D.N.Y. Sept. 21, 2007), report and recommendation adopted , 2007 WL 2973590 (N.D.N.Y. Oct. 9, 2007): Notwithstanding that court deemed time (one year) and geographical scope (United States) restrictions reasonable, employer failed to show that it had a legitimate business need for non-compete restriction against optical engineer since (i) former employee's services for employer were not unique or extraordinary, (ii) employer was able to make only, at best, a modest showing that the restriction was necessary in order to prevent misuse of trade secrets or confidential information and (iii) employer's President and CEO was unable to articulate a reason for requiring employees to sign a restrictive covenant or the need to extend it for one year throughout the United States.

FTI Consulting, Inc. v. Graves , No. 05 Civ. 6719, 2007 WL 2192200 (S.D.N.Y. Jul. 31, 2007): Non-compete clause restricting employee, a Senior Managing Director providing forensic litigation consulting services, for two years following termination of employment from engaging in a competing business within twenty-five miles of any location in which employer offered or provided consulting services to clients was unenforceable because employer failed to show employee's skills were unique and extraordinary - they could have been performed by another individual with comparable expertise - or that there was any client list, algorithm or other proprietary method of performing the services at issue; thus, it had not established a legitimate interest protected by the covenant.

The factual support submitted to the court by a party and the positions it has taken in prior restrictive covenant cases are critical to courts when deciding whether to enforce non-compete restrictions.

GFI Securities LLC v. Tradition Asiel Securities Inc. , No. 601183/08, slip op. (Sup. Ct. N.Y. County Jul. 28, 2008): Inter-dealer brokerage firm was unsuccessful in its attempt to enjoin competing firms from hiring away eighteen former employees when, among other things, (i) employer's allegations of irreparable harm were unsupported, including its failure to identify any business or customer relationships lost as a result of the alleged wrongful conduct, and statements to the contrary constituted mere speculation, (ii) no misappropriation of trade secrets or customer lists were at issue, (iii) employer failed to prove that employees were irreplaceable, given that certain of the brokers were junior brokers or trainees and employer was able to fill other positions overnight with experienced brokers and (iv) employer had taken contrary legal positions in an unrelated prior proceeding.

Non-Solicitation Restrictions Enforced

Courts remain generally willing to enforce non-solicitation clauses when the employer has established a legitimate interest in protecting its existing customer relationships from unfair competition.

Spinal Dimensions , 2007 WL 2296503 (Sup. Ct. Albany County Aug. 9, 2007): Among other things, barring defendants for 18 months following termination of employment from soliciting, servicing or doing business with any employer accounts or customers they called upon, sold products to or otherwise serviced.

Courts also continue to be more inclined to enforce such a covenant when the employee is educated and well compensated.

First Empire Secs., Inc. v. Miele , 17 Misc. 3d 1108(A), 851 N.Y.S.2d 57, 2007 WL 2894245 (Sup. Ct. Suffolk County Aug. 10, 2007): Enforcing eighteen month post-employment restriction barring a highly compensated employee - a Cornell University graduate who was then studying for his MBA degree - from soliciting any institutional clients that he serviced for First Empire Securities while he was employed by it. Relying on FINRA rules, the court, however, refused to ban the employee from transacting with clients if they contacted him without solicitation by him.

Courts also remain more likely to enforce provisions barring individuals from soliciting employees of their former employer, especially when the individual committed wrongful acts in connection with his departure.

Bond Street Group LLC v. Solomon-Page Group LLC , No. 602060/2007, 2007 N.Y. Misc. LEXIS 6380 (Sup. Ct. N.Y. County Aug. 3, 2007):Enjoining employee for a period of twelve months following his separation of employment from soliciting, inducing, or assisting any third party in soliciting or inducing any employee or temporary candidate of his former employer whom it had either placed at a corporate client or who had been paid by it. Among other things, the court determined that the balance of equities weighed in the employer's favor because two days prior to his last day of employment the employee apparently had deleted 4,000 e-mails before he left the company - including resumes and other information about temporary candidates - and had printed out his 2007 calendar from the employer's computer, which listed candidates and phone numbers.

Non-Solicitation Restrictions Not Enforced

Recent decisions have confirmed judicial disfavor in enforcing (i) non-solicitation of client restrictions against employees who had done business with clients prior to joining the employer or who did not have any relationship with the clients at issue during their employment and (ii) restrictions that effectively made the individual unable to secure employment.

Good Energy , 49 A.D.3d 331, 853 N.Y.S.2d 75: Ruling most of provision barring solicitation of clients and suppliers unenforceable because provision was unreasonable to the extent it restricted the employee from (i) dealing with clients that were not serviced by him during his tenure with employer or that came to employer solely because of a preexisting relationship with him and (ii) doing business with employer's energy suppliers since there were only a limited number of energy suppliers in the United States and the covenant effectively precluded him from continued employment in the industry.

Bond Street Group , 2007 N.Y. Misc. LEXIS 6380: Finding that non-solicitation of clients provision had not been breached by employee's solicitation of client he had worked with before joining the employer.

FTI Consulting , 2007 WL 2192200: Restriction prohibiting solicitation of clients for two years following employment was not enforced with respect to two clients because employer had no cognizable interest in the relationships, since they were not acquired during the course of employee's employment with employer.

Kevin B. Leblang is a Partner and Chair of the Employment Law Practice at Kramer Levin Naftalis & Frankel LLP. He can be reached at (212) 715-9306. Robert N. Holtzman is a Partner in the Employment Law Practice at the firm and can be reached at (212) 715-9513.

Please email the authors at kleblang@kramerlevin.com or rholtzman@kramerlevin.com with questions about this article.