The Basics: What is a Restrictive Covenant?
As is well known, many employers include provisions in employment and severance agreements which are designed to limit former employees’ actions after the employment relationship has ceased. A restrictive covenant is a contractual provision restricting the activities of a former employee or agent or the former owner of a company for a fixed period after the cessation of the employment relationship or after the sale of the company in order to protect the employer’s legitimate business interests.
The following types of provisions, among others, are restrictive covenants:
•non-compete provisions;
•non-solicit provisions (employees, clients);
•no-hire provisions; and
•“garden leave” provisions.
Such covenants can be found in a variety of employment-related documents such as:
•employment contracts;
•stock option agreements;
•severance agreements;
•long-term compensation plans; and
•employee manuals.
They are also often contained in agreements governing the sale of a company.
Enforceability of Restrictive Covenants
Generally, restrictive covenants are disfavored due to “powerful considerations of public policy which militate against loss of a man’s livelihood.” Columbia Ribbon & Carbon Mfg. Co., Inc. v. A-1-A Corp., 369 N.E.2d 4, 6 (N.Y. 1977). However, such provisions will be enforced where there is a legitimate interest protected and the scope of the restrictions are narrowly tailored.
In New York, the test to determine whether a restrictive covenant is reasonable and thus whether it will be enforceable is as follows: “A restraint is reasonable only if it (1) is no greater than is required for the protection of the legitimate interest of the employer; (2) does not impose undue hardship of the employee; and (3) is not injurious to the public.” BDO Seidman v. Hirshberg, 712 N.E.2d 1220, 1227 (N.Y. 1999).
Legitimate Protectable Interests
New York courts will enforce non-compete provisions only to the extent necessary to protect an employer’s legitimate interests and where they are reasonable in time and geographic area. Such courts consider the protection of the following kinds of information to be legitimate protectable interests and thus warranting enforcement of a restrictive covenant:
•Trade secrets and other confidential information;
•Protectable Client/Customer Relationships and Information; and
•“Unique and extraordinary” services (which is rarely found to be the case).
The Scope of Restrictions
New York courts enforce such restrictions only to the extent reasonable and necessary to protect legitimate interests. To determine whether a restrictive covenant is enforceable, courts analyze their scope along three criteria:
1. Geographic scope of the restriction;
2. Duration of the restriction; and
3. The scope of the business activity impacted.
1. Geographic Scope – To determine whether a non-compete provision is reasonable in geographic scope, courts in New York examine the particular facts and circumstances of each case. For example, in Natsource LLC v. Paribello, 151 F.Supp.2d 465, 471-72 (S.D.N.Y.2001), the court was willing to enforce very broad geographic restrictions on employees where the “nature of the business requires that the restriction be unlimited in geographic scope,” so long as the duration of those restrictions was short. (Emphasis added). However, in Pure Power Boot Camp, Inc. v. Warrior Fitness Boot Camp, LLC, 813 F. Supp. 2d 489 (S.D.N.Y. 2011), the court held that the non-compete provision in a fitness center operator’s employment agreement with prior employees, which prohibited employees from working at a competitor center anywhere in the world for ten years following employment at the center, was unenforceable since it was unreasonable in terms of duration and geographic scope.
2. Duration – New York courts have repeatedly held that temporal restrictions of six months or less are reasonable. See Ticor Title Ins. Co. v. Cohen, 173 F.3d at 70 (2d Cir. 1999); Natsource LLC, 151 F.Supp.2d at 470-71 (three-month non-compete). However, courts have also enforced non-competes of three years or more, usually where the geographic restriction is limited. In Novendstern v. Mount Kisco Med. Grp., 177 A.D.2d 623, 576 N.Y.S.2d 329 (1991), for example, the court found that a covenant restricting a physician from competing with his previous employer was enforceable because the prohibition on the physicians practicing in his specialties for three years was in a limited geographic area.
3. The Scope of the Business Activity Impacted – Under New York law, assuming a covenant by an employee not to compete surmounts its first hurdles, that is, that it is reasonable in time and geographic scope, enforcement will be granted only to the extent necessary:
a. to prevent an employee’s solicitation or disclosure of trade secrets;
b. to prevent an employee’s release of confidential information regarding the employer’s customers; or
c. in those rare cases where the employee’s services to the employer are deemed special or unique. Ticor Title Ins. Co. v. Cohen, 173 F.3d 63 (2d Cir. 1999).
Factors Considered by New York Courts
New York courts have also examined whether there was sufficient consideration, whether the agreement was incidental to the sale of a business, and whether an employee was preparing to compete to determine if a non-compete was reasonable. Such courts have found that future employment constitutes sufficient consideration to support a covenant not to compete. See Poller v. BioScrip, Inc., 974 F. Supp. 2d 204 (S.D.N.Y. 2013) (holding that “the fact that a restrictive covenant agreement is a condition of future employment does not automatically render such an agreement coercive and unenforceable”). Similarly, in Ikon Office Solutions v. Leichtnam, 2003 U.S. Dist. LEXIS 1469, *1, 2003 WL 251954 (W.D.N.Y. Jan. 3, 2003), the court found that the non-compete covenant was enforceable because the employee was an at-will employee who received continued employment as consideration. Moreover, financial benefits and an employee’s receipt of intangibles such as knowledge, skill, or professional status are also sufficient consideration to support a non-compete provision under New York law. See Arthur Young & Co. v. Galasso, 142 Misc. 2d 738, 741 (Sup. Ct. N.Y. County 1989).
The Future of Restrictive Covenants in New York State
In May 2017, New York Attorney General Eric Schneiderman arranged for legislation to be proposed in the New York legislature which would limit non-competes as follows:
•Non-competes would be void for employees with earnings of less than $75,000/year (to be increased each year for inflation);
•Non-competes must be provided to prospective employees by the earlier of a formal offer of employment or 30 days before the non-compete goes into effect;
•Non-competes would be unenforceable upon a termination without cause; and
•Employees would have a private cause of action seeking to invalidate non-competes which violate the statute.
New York City Proposes Partial Ban on Non-Compete Agreements
On July 20, 2017, the New York City Council proposed new legislation that would prohibit New York City employers from entering into a non-competition agreement with any “low-wage employee.” The proposed bill defines “low-wage employee” as any non-exempt employee, other than manual workers, railroad workers, and salespersons on commission. To be properly classified as exempt under the New York Labor Law, employees must be employed in a bona fide executive, administrative, or professional capacity and receive earnings in excess of $900 per week.
The proposed bill would also prohibit New York City employers from requiring any potential employees to enter into non-compete agreements unless, at the outset of the hiring process, the employer discloses in writing that the prospective employee may be subject to such an agreement. If passed by the New York City Council, the bill is expected to be signed by the Mayor and would take effect 120 days after being signed into law.
Richard B. Friedman
Richard Friedman PLLC
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