Kevin Schlosser Authors, "Restrictive Covenants Remain Ripe Area of Litigation" for NYLJ

Publication Source: New York Law Journal

As the Court of Appeals recently remarked, '[r]eported cases adjudicating the validity of post-employment restrictive covenants go back almost 300 years.'1 Courts have endeavored to balance 'the need of fair protection for the benefit of the employer against the opposing interest of the former employee and the public.'2 Recent case law provides continuing instruction and guidance in the enforcement of these ubiquitous contractual provisions.

In BDO Seidman v. Hirshberg, 93 NY2d 382, 690 N.Y.S.2d 854 (1999), the Court of Appeals reviewed the historical jurisprudence on the enforceability of restrictive covenants, confirmed what it viewed as the accepted principles and gave further guidance in determining whether and under what circumstances these provisions will be upheld as agreed. In BDO Seidman, a certified public accountant in a national accounting firm agreed 'that if, within 18 months following the termination of his employment, he served any client of [the firm's] Buffalo office, he would compensate [the firm] 'for the loss and damages suffered' in an amount equal to 1 1/2 times the fees [the firm] had charged that client over the last fiscal year of the client's patronage.' Id. at 387; 690 N.Y.S.2d at 856.

Citing several cases approving of restrictive covenants against physicians, the Court acknowledged that greater weight had been given to the interests of employers in restricting competition among 'professionals.' Id. at 389; 690 N.Y.S.2d at 857. Although it acknowledged that 'accountancy has all the earmarks of a learned profession,' the Court declined to afford the agreement in question such 'wider latitude,' refusing to enforce the restriction over 'clients with whom [the employee] never acquired a relationship through the direct provision of substantive accounting services during his employment' or 'to personal clients of defendant who came to the firm solely to avail themselves of his services and only as a result of his own independent recruitment efforts,' which were neither 'subsidized nor otherwise financially supported' by the firm. Id. at 389, 393; 690 N.Y.S.2d at 857, 859.

Balancing Interests

Recent case law since BDO Seidman indicates that courts have attempted to follow the Court of Appeals' admonition to balance the interests of the parties to ensure that the restriction 'is no greater than is required for the protection of the legitimate interest of the employer.' In particular, courts have performed a targeted factual analysis of the source of the clientele at issue, to determine whether the clients were derived from the employer's resources or through the employee's own relationships, reputation and/or skill.

In Milbrandt and Co., Inc. v. Griffin, 1 A.D.3d 327, 766 N.Y.S.2d 588 (2d Dept. 2003), for example, the trial court granted the plaintiff-employer a preliminary injunction enjoining its former employees from soliciting or accepting certain clients of the employer. On appeal, the Second Department stayed enforcement of the preliminary injunction pending determination of the appeal and then reversed and vacated the injunction in its entirety. Noting that there were serious issues of fact regarding whether the defendants made use of the employer's confidential customer information or whether the defendant-employee developed the goodwill of any customers 'without any support from his employer,' the court concluded that plaintiff could not establish a likelihood of success on the merits to such degree that it had a clear right to such relief. Id. at 328; 766 N.Y.S.2d at 589.

Similarly, in Elite Promotional Marketing, Inc. v. Stumacher, 2004 WL 1398232 (App. Div., 2d Dept., June 21, 2004), although not an employment case, the Second Department also focused on the source of the relationship between the party against whom the restrictive covenant was sought to be enforced and the clients being solicited. In Stumacher, the non-solicitation provision was contained in an agreement by which an entity had promised to solicit credit card applications for a particular company, while agreeing not to solicit work from another credit card company. The company in whose favor the non-solicitation was granted alleged that a breach of the non-solicitation clause justified its refusal to pay the other party for the services it did perform under the contract.

Citing BDO Seidman's admonition that a 'restraint must be reasonable such that it 'is no greater than is required for the protection of the legitimate interest' of the party seeking enforcement,' the Second Department found the trial court properly determined that the contracting party was permitted to solicit a client with whom it had a 'pre-existing relationship.'

In Johnson Controls, Inc. v. A.P.T. Critical Systems, Inc., 2004 WL 1432582 (S.D.N.Y. June 24, 2004), U.S. District Judge Peter K. Leisure thoroughly analyzed the cases and principles applicable to non-compete agreements, doing a careful balancing act between the employer's and employee's interests. Plaintiff there sought a preliminary injunction to prohibit two former employee/managers from (1) soliciting or servicing existing or potential clients of the plaintiff, who were solicited or served by the defendants or their subordinates while employed by plaintiff; (2) using or disclosing plaintiff's confidential information and trade secrets; (3) interfering with current or prospective client relationships of plaintiff; and (4) breaching their fiduciary obligations to plaintiff. Both former employees signed broad confidentiality and non-competition agreements during their employment with plaintiff.

In determining whether the agreements were enforceable and to what extent, Judge Leisure first noted that 'New York courts have endeavored to balance public policy concerns relating to the benefits of competition and the unfettered flow of talent and ideas in our economy with employers' legitimate right to protect the fruits of their labor . . . , the idea being that the proper balancing of these factors will produce the most wealth and innovation . . . .' The court added 'that on a less grand scale the interests to be balanced are those of the individual employer and employee.'

Acknowledging that he must recognize the parties' 'freedom to contract,' Judge Leisure found the court's duty was 'merely to determine the extent to which the parties' agreement is reasonable under this analysis and to enforce it accordingly.' (Emphasis in original.)

After concluding that the covenant was reasonable in time and geographical scope, Judge Leisure noted that an employer 'has a legitimate interest in protecting client relationships developed by an employee at the employer's expense' (relying upon and quoting from, inter alia, BDO Seidman). Judge Leisure then focused on the evidence adduced at the hearing to determine whether the clients in question were developed solely from the employee's own independent efforts and/or in reliance upon the employee's individual services.

The court found that there was no compelling evidence that any clients who came to the employer during the employee's tenure were obtained through the employee's 'independent recruitment efforts' and, while the employee did develop extensive, significant client relationships, 'these relationships were financed and supported by [the employer], which paid [the employee's] salary and the salary of the other engineers that worked under him.'

While the court did find that the employee was a 'well-regarded expert' in the applicable field and noted that certain customers testified they would seek out the employee's services over any other engineer, no matter what company he worked for, it declined 'to read BDO Seidman's protection of employees' independent relationships so broadly as to find that [the employee's] unique reputation [within the technical field at issue] constitutes an independent relationship, distinct from the larger client relationship financed and maintained, in large part, through [the employer's] efforts.'

Nevertheless, following BDO Seidman's suggestion to enforce restrictive covenants only to the extent necessary to protect the employer's legitimate interests, Judge Leisure refused to enforce that portion of the non-compete agreement prohibiting the employees from obtaining business from 'potential' clients of the plaintiff, who were merely solicited at the direction of the two defendant employees while they were employed by plaintiff. Thus, Judge Leisure only enjoined and restrained the employees from directly or indirectly servicing existing customers of the plaintiff, who were served or solicited by the defendants or by other employees of plaintiff under the defendants' supervision.

Covenants by Physicians

On the other hand, in Coppa v. Lederman, 2004 WL 884258 (E.D.N.Y. March 11, 2004), U.S. District Judge I. Leo Glasser emphasized the special treatment afforded to restrictive covenants signed by physicians, thereby enforcing in its entirety a restrictive covenant contained in an employment agreement between a dermatologist and the professional corporation by whom she was employed, which prohibited the dermatologist from directly or indirectly practicing dermatology within the borough of Staten Island for a period of two years following her termination of employment.

Relying upon BDO Seidman's recognition that 'greater weight' should be given to the interests of the employer when determining the enforceability of restrictive covenants among professionals, Judge Glasser continued that the 'interests of the employer have enjoyed a solicitous consideration by the Court where the issue of the enforceability of a restrictive covenant is in an employment agreement between doctors.' Judge Glasser also found it particularly significant that the physician/employee in question explicitly acknowledged in the employment agreement itself that the 'restrictive covenants are reasonable in extent, duration and geographical scope.' Thus, Judge Glasser refused to grant the employee's motion for a preliminary injunction to enjoin enforcement of the restrictive covenant.

Conclusion

Restrictive covenants remain a ripe area of litigation. Courts appear to continue to attempt to weigh the interests of both employer and former employee, to strike a balance between protecting an employer's investment in its customer base and goodwill and an employee's freedom to earn a living through fair competition.