Employers frequently condition the payment of post-employment or deferred compensation on an employee's compliance with a noncompete agreement. Such an arrangement has long been enforceable in New York under the "employee choice" doctrine. This doctrine holds that an employee who chooses to resign and violate his or her noncompetition obligations can be deemed to have waived any legal right to post-employment compensation, but does not apply the strict scrutiny to which noncompete agreements usually are subject. The employee choice doctrine is based on the premise that a resigning employee is given the choice of either preserving his or her right to compensation by refraining from engaging in competitive employment, or forfeiting that right by choosing to compete with a former employer.
The New York Court of Appeals' recent decision in Morris v. Schroder Capital Management, 7 N.Y. 3d 616 (2006), has made it even more difficult for employees to challenge forfeiture provisions linked to noncompete agreements. In Morris, the Court answered a question certified to it by the Court of Appeals for the Second Circuit: "[W]hether the constructive discharge test is the appropriate legal standard to apply when determining whether an employee voluntarily or involuntarily left his employment for purposes of the employee choice doctrine."
The plaintiff in Morris was employed as Senior Vice President and head of domestic equities at Schroder Capital ("Schroder"). A portion of his annual year-end bonus was deemed a "deferred compensation award," which did not vest until three years after the date of issue. The company's deferred compensation plan expressly provided that if an employee resigned and accepted employment with a competitor prior to the end of the three-year vesting period, all nonvested deferred compensation would be forfeited. When Morris resigned to establish a hedge fund in competition with Schroder, he was told that his deferred compensation was forfeited.
Morris sued for breach of contract, asserting that Schroder had forced him to resign by significantly diminishing his job responsibilities. Specifically, Morris claimed that the company had reduced the amount of investment assets over which he had control from $7.5 billion to $1.5 billion. Morris argued that the standard for determining whether a resignation was voluntary or involuntary for forfeiture purposes should be whether the employer "was willing to employ the employee in the same or comparable job" for which he was hired.
The trial court rejected Morris' position and instead held that an employee who resigns and seeks to avoid forfeiture must satisfy the more stringent "constructive discharge" standard. To establish a constructive discharge, an employee must prove that an employer deliberately and intentionally made his or her working conditions so intolerable that a reasonable person in the employee's situation would have felt compelled to resign. The Court of Appeals in Morris agreed that the "constructive discharge test is appropriate in the context of the 'employee choice' doctrine."
The Morris decision makes it more difficult for employees to violate post-employment noncompete agreements without forfeiting their nonvested compensation and benefits. In light of Morris , New York employers seeking to bolster their protection against competitive activities by former employees should be sure that their compensation and benefit plans contain forfeiture provisions that may help to deter the violation of post-employment noncompete agreements.
Kevin B. Leblang is a Partner and Chair of the Employment Law Practice of Kramer Levin Naftalis & Frankel LLP. He can be reached at (212) 715-9306. Robert N. Holtzman is a Partner in the Employment Law Practice of Kramer Levin. He can be reached at (212) 715-9513.