Category: Employment Law Counseling

Current State of Restrictive Covenants (Other Than Non-Competes) in New York by Richard Friedman

Current State of Restrictive Covenants (Other Than Non-Competes) in New York

What is a Restrictive Covenant?

Our last blog article provided an update on the state of New York law concerning non-compete provisions. Although the subject of non-competes continues to attract a lot of media attention, and will no doubt lead to a further update by us over the next year or so, we turn now to the state of New York law concerning restrictive covenants other than non-competes. A restrictive covenant is a contractual provision that many employers include in employment and severance agreements. They are designed to limit the activities of a former employee or a former owner of a company for a fixed period of time following the end of the employment relationship or after the sale of a company to protect the former employer’s or buyer’s supposed legitimate business interests. In addition to employment and severance agreements, these covenants can often be found in such documents as:

  • Stock option agreements;
  • Long-term compensation plans; and
  • Agreements governing the sale of a company.

Enforceability of Restrictive Covenants

As is well known, New York courts generally disfavor restrictive covenants contained in employment contracts and will only enforce them when they are found to be reasonable and necessary to protect an employer’s legitimate business interests.1 This is because the public policy of the state favors economic competition and individual liberty and seeks to shield employees from the superior bargaining position of employers.2 The test New York courts use to determine whether a restrictive covenant is reasonable was articulated by the Court of Appeals in BDO Seidman v. Hirshberg. It stated that “[a] restraint is reasonable only if it (1) is no greater than is required for the protection of a legitimate interest of the employer; (2) does not impose undue hardship of the employee; and (3) is not injurious to the public.”3 Applying this test, courts analyzing a restrictive covenant take a two-step approach:4

  1. The court first considers whether the covenant is reasonable in scope and duration; and
  2. If so, it considers whether the contract, as written, is necessary to protect the employer’s legitimate interest.

Scope and Duration

To be enforceable, a restrictive covenant must not be more extensive, in terms of time and place, than necessary to protect the legitimate interests of the employer. A court may find them to be unreasonable when the restriction covers a geographic areas where the employer does not compete, or where the provision would effectively prevent the employee from continuing to work in a particular industry.5 For this reason, New York courts have rarely found worldwide restrictions reasonable in any context.

Legitimate Interests

New York courts have held that legitimate interests are limited to the protection against misappropriation of the employer’s trade secrets, confidential customer lists, or protection from competition by a former employee whose services are unique or extraordinary.6 Additionally, an employer has a legitimate interest in protecting client relationships or goodwill developed by an employee at the employer’s expense.7

Types of Restrictive Covenants

While non-compete provisions discussed in our last blog article are the most common type of restrictive covenants, New York courts recognize other types of restrictive covenants such as:

  • non-solicitation provisions for clients or customers;
  • no-hire provisions;
  • and “garden leave” provisions.

 1. Non-solicitation Provisions

A non-solicitation provision is a restrictive covenant which prohibits former employees, for a specific period of time after the employment relationship ceases, from soliciting the former employer’s customers or providing competing services to those customers.8 They often also prohibit the former employee from assisting the new employer in trying to secure business from the former employer’s customers.9

A non-solicitation provision as applied to customers is typically easier to enforce than a non-compete provision because it only restricts the former employee from soliciting and/or performing services for particular customers for a specified time period.10

Yet New York courts have held found that a non-solicitation provision is too broad to be enforced as written if it is not keyed to one of the following three legitimate protectable interests:

      • the uniqueness of the employee (which is difficult to establish);
      • the protection of the employer’s trade secrets or confidential information; or
      • the competitive unfairness of allowing competition that adversely impacts the employer’s goodwill.11

Thus, a court will find a non-solicitation clause to be overbroad if it prohibits an employee from servicing clients who came to the firm for the purpose of availing themselves of the employee’s services as a result of the employee’s own recruitment efforts.12 But, if the patronage of the client, was acquired through the expenditure of the employer’s resources, rather than the employee’s, then maintaining that client relationship would likely be deemed a legitimate interest and in such event the provision would be enforced.13

 2. No-hire Provisions

A non-solicitation clause that applies to the solicitation of employees has been referred to by courts as a non-recruitment or a no-hire provision. Conduct that violates a clause such as this includes identifying employees who would be recruited, direct or indirect solicitation of employees, and speaking to employees concerning how they would like to be compensated by the new employer.14

The New York Court of Appeals has not considered whether a covenant not to solicit employees is enforceable. However, both the Second Department and New York federal courts have stated that New York recognizes the enforceability of covenants not to solicit employees.15 Like other restrictive covenants, they are subject to a reasonableness analysis but are considered inherently more reasonable than a covenant not to compete.16 The United States District Court for the Southern District of New York has gone as far as saying that these sorts of provisions can be viewed as prima facie enforceable when they are reasonable in scope and limited in duration.17

 3. “Garden Leave” Provisions

A “garden leave” provision is an extended notice provision that requires departing employees to give the company a certain period of advance notice when they intend to leave the company.18 It is a variation of a notice of termination provision and can be used as an alternative to or in addition to a traditional non-compete provision to restrict competition by departing employees. Such a provision gives employers the option to pay the employee through the balance of the notice period but direct them not to come to work or perform services, giving the employees leave to “tend to their gardens” or any other pursuit outside of the job, provided that the employees do not compete with their former employer.19 Extended notice provisions may be mutual but can also require that only the employee provide notice, with no similar obligation on the employer. Where mutual, these provisions without exception (to our knowledge) do not require such notice from employers where the employee is being terminated for cause.20

Richard Friedman
Richard B. Friedman
Richard Friedman PLLC

200 Park Avenue Suite 1700
New York, NY 10166
TEL: 212-600-9539
rfriedman@richardfriedmanlaw.com
www.richardfriedmanlaw.com
www.richardfriedmanlaw.com/blog
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1  BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 389 (1999).
2  Mathias v. Jacobs, 167 F.Supp. 2d 606, 611 (S.D.N.Y. 2001).
3  93 N.Y. 2d at 389.
4  Devos, Ltd v. Record, 2015 WL 9593616 (E.D.N.Y. 2015).
5  Good Energy, L.P. v. Kosachuk, 49 A.D.3d 331 (1st Dep’t 2008). 
6  BDO Seidman, 93 N.Y.2d at 389.
7  Gundermann & Gundermann Ins. v. Brassill, 46 A.D.3d 615 (2d Dep’t 2007).
8  4B N.Y.Prac., Com. Litig. In New York State Courts § 80:8 (4th ed.).
9  Id. 
10  Contempo Communications, Inc. v. MJM Creative Services, Inc., 182 A.D.2d 351 (1st Dep’t 1992).
11  GFI Brokers, LLC v. Santana, 2008 WL 3166972 (S.D.N.Y. 2008).
12  Zinter Handling, Inc v. Britton, 46 A.D.3d 998 (3d Dep’t 2007); Pure Power Boot Camp, Inc v. Warrior Fitness Boot Camp, LLC 813 F. Supp. 2d 489 (S.D.N.Y 2011).
13  Marshall & Sterling, Inc v. Southard, 148 A.D.3d 1009 (2d Dep’t 2017); see also Garber Bros, Inc. v. Evlek 122 F. Supp. 2d 375, 379 (E.D.N.Y. 2000). 
14  Marsh USA Inc. v. Karasaki, 2008 Wl 4778239 (S.D.N.Y. 2008). 
15  Veraldi v. American Analytical Laboratories, Inc., 271 A.D.2d 599 (2d Dep’t 2000); MasterCard International Incorporated v. Nike, Inc., 164 F.Supp 3d 592 (S.D.N.Y. 2016).
16  Renaissance Nutrition, Inc v. Jarrett, 2012 WWl 42171 *5 (W.D.N.Y. 2012); see also MasterCard International, 2016 WL 797576 (S.D.N.Y. 2016) (stating that “the reasonableness test set forth in BDO Seidman applies to non-recruitment provisions.”).
17  General Patent Corp. v. Wi-Lan Inc., 2011 WL 5845194 (S.D.N.Y. 2011). 
18  4B N.Y.Prac., Com. Litig. In New York State Courts § 80:10 (4th ed.).
19  Id.
20  Id.
Current State of Non-Competes Under New York Law by Richard Friedman

Current State of Non-Competes Under New York Law

What is a Non-Compete?

As all of our readers undoubtedly know, a non-compete provision is a type of restrictive covenant that many employers include in employment and severance agreements to restrict a former employee’s ability to work for a competitor after the cessation of his or her employment.

Enforceability of a Non-Compete?

Although non-compete provisions are generally disfavored in New York1, such a provision is likely to be enforced if “‘it is reasonable in time and area, necessary to protect the employer’s legitimate interests, not harmful to the general public and not unreasonably burdensome to the employee.’”2 The common law standard of reasonableness was articulated by the New York Court of Appeals twenty years ago in BDO Seidman v. Hirshberg3 in which it held that a non-compete is reasonable only if it:

  1. Is no greater than required to protect an employer’s legitimate protectable interests;
  2. Does not impose undue hardship on the employee or is harmful to the general public; and
  3. Is reasonably limited temporally and geographically.

This approach is in sharp contrast to that of several states such as California, Montana, North Dakota, and Oklahoma which ban non- competes for employees either outright or under very limited circumstances.

Employer’s Legitimate Protectable Interests

In New York, an employer’s legitimate protectable interests include4:

  • Protection of trade secrets;
  • Protection of customer relationships;
  • Confidential customer information; and
  • “Unique” services.
    • This latter category is rarely invoked since the employee must render unique services that cannot be easily replaced.

Scope of Restrictions

New York courts will only enforce non-competes to the extent that they are reasonably necessary and narrowly tailored. If the court determines that a non-compete is necessary to protect a legitimate interest, it will then examine the following three factors:

  1. Geographic scope of the restriction. New York courts generally conduct a fact-based analysis on a case-by-case basis. For example, when the “nature of the business requires that the restriction be unlimited in geographic scope,” courts may be willing to enforce a broad geographic restriction so long as the duration of the restrictions are short. Natsource LLC v. Paribello, 151 F.Supp.2d 465 471-72. This is in contrast with Power Boot Camp, Inc. v. Warrior Fitness Boot Camp, LLC, 813 F. Supp. 2d 489, 507 (S.D.N.Y. 2011), where the court held a non-compete unreasonable because the unlimited geographic scope prevented former employees from accepting “any job in the fitness industry that uses obstacle courses … or employs the term boot camp.”
  2. Duration of the restriction. When reviewing the length of non-competes, New York courts have held repeatedly that restrictions of six months or less are generally reasonable. However, like the geographic limitation, this analysis is conducted on a case-by-case basis and courts have found certain longer non-compete provisions reasonable in light of other circumstances. For instance, applying New York law, the U.S. District Court for the Southern District of New York held non-compete provisions of three and five years arising out of an employment agreement and an asset purchase agreement, respectively, with the employer’s former president were not excessive even though the longer period was equal to one-third of the former president’s 15 years of experience in the industry.5
  3. The scope of the business activity impacted. Courts will not enforce a non-compete covenant where the scope of the business activity impact is deemed to be too broad or it is not shown to be necessary to protect trade secrets or confidential customer lists.6
    • Example where a non-compete was found to be unreasonable:
      • A non-compete that prohibited the former employee from soliciting an employee’s entire former client base where the restriction included client relationships which were established by and maintained by the employee.7

Other Factors and Situations Considered by New York Courts

In addition to the factor tests New York courts use to determine whether a non-compete is reasonable, a number of other factors come into play.

Sale of a Business. When there has been a sale of a business, non-compete provisions are more likely to be considered reasonable because they are “designed to protect the goodwill integral to the business from usurpation by the former owner while at the same time allowing an owner to profit from the goodwill which he may have spent years creating.”8 Additionally, non-compete provisions incidental to the sale of a business by a stock purchase agreement may also be enforced against shareholders with minority stock ownership.9

Consideration. Under New York law, future employment is sufficient consideration for a non-compete clause.10 Continued employment of an at-will employee has likewise been found to be sufficient consideration to support a covenant not to compete.11

An issue arises when an employee with a non-compete is terminated without cause. As stated in my blog article entitled “ENFORCEABILIY OF NON-COMPETE PROVISIONS IN NY WHEN INVOLUNTARY TERMINATION IS WITHOUT CAUSE,” which is posted on our website, the Second Department and at least three judges in the Southern District of New York have ruled that non-compete clauses are categorically precluded from enforcement when an employee has been involuntarily discharged without cause.12 However, other New York courts have ruled that there is not a per se rule applicable to all non-compete provisions. Most notably, in Morris v. Schroder Capital Management International,13 the Court of Appeals stated that “a court must determine whether forfeiture is ‘reasonable’ if the employee was terminated involuntarily without cause.”14

Future of Non-Competes in New York

In September 2018, the New York Attorney General’s Office announced a settlement with WeWork Companies that ended its use of overly broad non-compete provisions. This ended the company’s routine practice of requiring all levels of employees to sign a contract including a non-compete restriction regardless of job duties, knowledge of confidential information, or compensation.

This settlement was further evidence of a commitment by the New York AG’s Office to combat the use of non-competes for low-level and low-wage employees. In 2017, the AG’s Office had proposed BILL A07864A to limit non-competes. The bill provided the following:

  • 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 termination without cause; and
  • Employees would have a private cause of action seeking to invalidate non-competes that violate the statute.

The passage of time since the bill was proposed without its enactment leads this commentator to believe that it is unlikely to become law in the foreseeable future.

Richard Friedman

Richard B. Friedman
Richard Friedman PLLC

200 Park Avenue
Suite 1700
New York, NY 10166
TEL: 212-600-9539
rfriedman@richardfriedmanlaw.com
www.richardfriedmanlaw.com
www.richardfriedmanlaw.com/blog
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1Sutherland Global Services, Inc. v. Stuewe, 73 A.D.3d 1473, 1474 (4th Dep’t 2010).

2 Riedman Corp. v. Gallager, 48 A.D.3d 1188, 1189 (4th Dep’t 2008), quoting Reed, Roberts Associates, Inc. v. Strauman, 40 N.Y.2d 303, 307 (1976).

3 BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 389 (1999).

4 Arthur J. Gallagher & Co. v. Marchese, 96 A.D.3d 791, 792 (2d Dep’t 2012); 1 Model Management, LLC v. Kavoussi, 82 A.D.3d 502, 503 (1st Dep’t 2011).

5 Uni-World Capital L.P. v. Preferred Fragrance, Inc., 73 F.Supp.3d 209, 232 (S.D.N.Y. 2014).

6 Sutherland, 73 A.D.3d at 1473.

7 Good Energy, L.P. v. Kosachuk, 49 A.D.3d 331, 332 (1st Dep’t 2008).

8 Reed, Roberts Associates, Inc. v. Strauman, 40 N.Y.2d 303, 307 (1976); 4D N.Y.Prac., Com. Litig. in New York State Courts § 105:21 (4th ed.).

9 See Shearson Lehman Bros. Holdings, Inc. v. Schmertzler, 116 A.D.2d 216, 223 (1st Dep’t 1986) (stating that refusing to enforce a non-compete against someone with “so small an ownership interest … would place an unacceptable barrier in the path of sale of businesses in which ownership is widely diversified … and good will is clearly a central concern in the acquisition”).

10 See Poller v. BioScrip, Inc., 974 F. Supp. 2d 204, 224 (S.D.N.Y. 2013).

11 Id.

12 See, e.g., Grassi & Co., CPAs, P.C. v. Janover Rubinroit, LLC, 82 A.D.3d 700 (2d Dep’t 2011); Arakelian v. Omnicare, Inc., 735 F. Supp. 2d 22 (S.D.N.Y. 2010).

13 7 N.Y. 3d 616,621 (2006).

14 See also Hyde v. KLS Professional Advisors Group, LLC, 500 Fed.Appx. 24 (2d Cir. 2012); Brown & Brown, Inc. v. Johnson, 115 A.D.3d 162 (4th Dep’t 2014), rev’d on other grounds, 2015 WL 3616181 (2015).

5TH ANNUAL EMPLOYMENT LAW INSTITUTE by Richard Friedman

Employer Best Practices for Conducting Sexual Harassment Investigations

A female mid-level employee walks into her employer’s Human Resources (“HR”) Department offices and states that she would like to file a sexual harassment complaint against a senior executive. The employee then lays out her story and describes her fears of retaliation from the executive. This situation can be very difficult for in-house counsel because they are presumably concerned about the well-being of all employees, promoting a suitable company culture, and providing a safe and positive environment which hopefully helps the company to thrive.

Given the seriousness of sexual harassment allegations, which has certainly been highlighted by the #MeToo Movement, it is obviously imperative that employers conduct thorough and impartial investigations into allegations of sexual harassment. In order to ensure a proper investigation occurs, employers should address the following issues, among others.

Who should conduct the investigation?

What is the proper scope?

How should the witness interview be conducted?

In what manner and to whom should the conclusions be communicated?

With proper procedures followed by capable HR personnel, in-house counsel, and/or outside counsel, employers can ensure that a fair investigation is conducted and reduce or eliminate the possibility of company liability for an improper investigation.

Who is an Appropriate Investigator?

Many employers utilize HR staff members or in-house counsel to conduct internal investigations due to their understanding of company policies and/or employment law. Although obviously cost-effective, this approach can eventually result in allegations of conflicts of interest because of the employment relationship between the employer and the employee-investigator. This is particularly true when a senior executive is the target of the investigation.

Employing outside counsel to conduct sexual harassment investigations is the safest way to proceed when the allegations are extremely serious and/or one or more senior executives are involved. Consideration should also be given to having outside counsel conduct an investigation when the complainant is a former employee to reduce or eliminate later allegations in the litigation that I believe is more likely to ensue under such circumstances that the investigation was flawed because the investigator was conflicted. Retaining outside counsel also allows in-house counsel and HR employees to focus on other meaningful workplace functions.

What is the Appropriate Scope of an Investigation?

Of course, the scope of the investigation depends on the nature of the complaint and may change as new facts come to light. That said, the investigator(s) must probe the credibility of the alleged harasser(s), victim, and witnesses and evaluate whether the company’s processes and practices for handling sexual harassment claims were followed. In addition, investigators should make recommendations if they believe (i) certain company processes or practices need to be revised, (ii) systemic problems exist, or (iii) an HR audit is warranted.

A preliminary investigation plan should include a description of known facts and specific issues to be explored, a list of possible witnesses as well as other individuals with relevant information, and known or possible documentary evidence. It should also contain a proposed timeline for completion of the investigation. Potentially relevant evidence includes records of prior complaints, witness interviews, personnel files, performance evaluations, compensation records, timekeeping records, emails and other electronically stored information, voicemails, audio/video recordings, employee notes and logs, and background checks. In determining the appropriate investigatory strategy, investigators should be mindful of the potentially disruptive and unnerving effect of a hard-nosed investigation into alleged employee misconduct.

How Should Witness Interviews Be Conducted?

At the outset of employee interviews, in-house or outside counsel must provide Upjohn warnings to ensure the integrity and confidentiality of employee interviews. In the landmark 1981 case Upjohn Co. v. United States, the United States Supreme Court found that a company’s attorney-client privilege protected communications between attorneys and a company’s employees regardless of their seniority and authority. The Court’s holding gave rise to the Upjohn Warning in which attorney investigators hired by a company inform employee interviewees that the attorney-client relationship exists only between the attorney and the employer. Failure to provide an Upjohn Warning has resulted in employee witnesses being afforded the right to claim the attorney-client privilege with respect to their communications with investigative counsel representing the company.

Another issue that sometimes arises is whether to allow employees being interviewed to have their personal counsel or another representative present. In order to protect the privacy rights of the persons involved, among other reasons, it is my view that employers should generally avoid allowing counsel or a representative to sit in on interviews. If it is permitted under unusual circumstances, employers should articulate guidelines in advance to prevent disruptions, questions, and responses made by an attorney on behalf of his or her client or a representative on behalf of his or her principal.

Although efforts should be made to ensure the confidentiality of information obtained from witness interviews, employers need to understand that relying on the propriety of an investigation as a defense in a litigation may eventually result in a waiver of the attorney-client privilege for that investigation.

Investigative Report

In many routine investigations, it is perfectly appropriate for in-house counsel or HR employees to speak separately with the complainant and the subject of the investigation, send separate confirmatory emails, and not prepare a formal report. However, if counsel believes that remedial or other actions may or will need to be taken, the target is a senior employee, and/or litigation is reasonably likely to ensue, a written report should be prepared absent extraordinary circumstances. When PowerPoint slides are used to make a presentation of the report, attendees, including Board members, should not be allowed to retain any slides because of possible litigation.

Takeaways

Of course, no single approach will suit all companies or all scenarios when sexual harassment allegations have been made so it is imperative for an employer to give careful consideration to what is appropriate given the particular circumstances. However, there are some universal guidelines I believe employers should follow when choosing an investigator. Employers should try to confirm that the investigator is:

  1. well-trained on proper investigation procedures;
  2. knowledgeable about employment and sexual harassment law and company policies;
  3. disinterested in the particular investigation even if an employee of the company at issue;
  4. a skilled interviewer who knows how to listen and when to probe to find relevant information; and
  5. has an acute eye for details since some may eventually prove to be important.

Investigators with these virtues, whether employed by the company or outside counsel, should be able to conduct competent investigations in even the most trying of circumstances. Finally, the form of any report should be governed by the employment status of the complainant(s), the nature of the allegations, and the seniority of the target(s) of the investigation.

Richard B. Friedman
Richard Friedman PLLC

830 Third Avenue, 5th Floor
New York, New York 10022
TEL: 212-600-9539
rfriedman@richardfriedmanlaw.com
www.richardfriedmanlaw.com
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Clawing Back Compensation from a Sexual Harassment Predator in the #MeToo Era

The September 9 resignation of CBS Chairman, President, and Chief Executive Officer Les Moonves after six women accused him in the New Yorker of engaging in sexual harassment years ago, which came about six or so weeks after the New Yorker had published an article in which six other women had made the same accusations, brings to mind two questions that some companies, particularly public ones accountable to their shareholders, will confront as the #MeToo movement continues to have a wide impact on Corporate America: can a company claw back compensation from a former executive found to have engaged in sexual harassment and, if so, is it in the company’s interests to try to do so? This article will briefly discuss two cases in which the faithless servant doctrine was invoked under New York law this year to try to claw back compensation with varying results.

In our recent article, Clawing Back All Compensation From The ‘Faithless Servant’ Under New York Law, we pointed out that the faithless servant doctrine is a potentially powerful tool that employers can use to try to claw back all compensation paid to a former employee upon demonstrating that the former employee repeatedly engaged in disloyal and unfaithful conduct during his or her employment. The theory underlying the doctrine is quite simple: one who has acted unfaithfully or in bad faith in an employment context should not be entitled to retain his or her compensation.    

To provide a remedy for employers, employees found to be disloyal under the faithless servant doctrine in New York are generally “entitled to no compensation, at least for the period of the agent’s disloyalty.” Yukos Capital S.A.R.L. v. Feldman, 2017 U.S. Dist. LEXIS 16438, *3 (S.D.N.Y. 2017). However, two cases decided in recent months under New York law apply the doctrine in very different ways depending on whether the alleged misconduct was financial in nature or sexual in nature.

In Salus Capital Partners, LLC v. Moser, 289 F. Supp. 3d 468 (S.D.N.Y. 2018), employees reviewed emails of the company’s former CEO who had been terminated without cause and realized that the CEO had concealed unauthorized personal charges on his corporate credit card. In an arbitration proceeding, the employer invoked the faithless servant doctrine to obtain a forfeiture of compensation and recoup the fees it had paid to outside counsel for investigating the former CEO’s misconduct. The U.S. District Court for the Southern District of New York upheld the former arbitrator’s findings that the former CEO had:

  • spent just under $100,000 in improper credit card charges for patio furniture, watches, and family travel;
  • falsified a vendor’s invoices totaling approximately $100,000 for certain audio visual work which was done at his home; and
  • spent $35,000 for personal use of the company’s NetJets account.

The court also upheld the arbitrator’s award of $879,514 in compensation forfeiture and $748,155 in attorneys’ fees for the investigation of the former CEO’s conduct. The court stated as follows: “[The CEO’s] purported exemplary performance of his duties when he was not stealing from plaintiff does not insulate him from the application of the faithless servant doctrine.” Id. at 480 (quoting City of Binghamton v. Whalen, 141 A.D.3d 145, 148 (3d Dep’t. 2016)) (internal quotations omitted).

The investigative costs were recoverable pursuant to an indemnification clause in the applicable agreements. The same misconduct that formed the basis for the compensation forfeiture triggered the indemnity obligation. 

Although the faithless servant doctrine was first recognized by the New York Court of Appeals over 125 years ago, there have been very few cases involving sexual harassment as the underlying act of disloyalty. In one such case, Astra USA, Inc. v. Bildman, 455 Mass. 116 (2009), the Massachusetts Supreme Court, applying New York law, found that a former CEO guilty of fiscal improprieties and habitual sexual harassment which caused financial and reputational harm to Astra USA, Inc., his former employer, must forfeit his entire compensation under the faithless servant doctrine.  

However, in Pozner v. Fox Broadcasting Company, 59 Misc. 3d 897 (Sup. Ct. N.Y. Cty. 2018), Justice Saliann Scarpulla of the New York County Supreme Court’s Commercial Division, considered by many to be one of the crown jewels of the state judiciary system, declined to extend the faithless servant doctrine to require Cliff Pozner, a former Executive Vice President at Fox Broadcasting Company (“Fox”), to forfeit compensation resulting from his termination for cause because of sexual harassment allegations directed against him. The court held that Pozner had not breached his duty of loyalty to Fox despite his alleged misconduct. In so holding, the court distinguished the action from Astra, stating that breach of the duty of loyalty to an employer “has only been extended to cases where the employee act[s] directly against the employer’s interests – as in embezzlement, improperly competing with the current employer, or usurping business opportunities,”and not in cases where sexual harassment was the only alleged impropriety. Id. at 901.

The Pozner Court also distinguished Colliton v. Cravath, Swaine & Moore, LLC, 2008 U.S. Dist. LEXIS 74388 (S.D.N.Y. 2008), in which the U.S. District Court for the Southern District of New York had held that an attorney was subject to a forfeiture of his compensation because, by committing statutory rape and patronizing a prostitute, he was incapable of meeting the ethical standards of his profession constituting “a substantial breach of his duty of loyalty to Cravath.” Id. at *17. The Court reasoned that the conduct at issue in Colliton rendered the disloyal employee unable to fulfill the terms of his employment and that his entire employment was the product of fraudulent concealment, whereas there were no allegations of fraud in the Pozner action. Id.  

Incredibly, the Pozner Court failed to consider sexual harassment to be an act “directly against … a company’s interests” even though it can (i) lead to an untenable work environment, (ii) harm valued employees, and (iii) severely damage a company’s reputation with multiple constituencies such as employees, customers, and suppliers. It also appears that the court did not believe that the act of concealing one’s sexual harassment to retain one’s job constitutes fraudulent concealment.

Some would view the Pozner ruling as tone deaf not only because of the financial and reputational harm and elevated scrutiny often faced by companies entangled in high-profile sexual harassment scandals, but also because the faithless servant doctrine was intended to serve as a deterrent to employees from engaging in similar acts in the future. In Diamond v. Oreamuno, 24 N.Y.2d 494 (1969), for example, the New York Court of Appeals held that the remedy for breaches of fiduciary duties of loyalty was not simply “to compensate the plaintiff for wrongs committed by the defendants, but to … prevent them, by removing from agents and trustees all inducement to attempt dealing for their own benefit in matters which they have undertaken for others, or to which their agency or trust relates.” Id.

Indeed, there are surely victims of sexual harassment in the workplace who have not reported it over the years because of overt or implicit threats made by both the perpetrators of the harassment who are senior to them in the organization where they work. Of course, only time will tell how the New York appellate courts will treat Pozner and subsequent cases like it where the faithless servant doctrine is invoked to try to recoup compensation against perpetrators of sexual harassment in the workplace.

Richard B. Friedman
Richard Friedman PLLC

830 Third Avenue, 5th Floor
New York, New York 10022
TEL: 212-600-9539
rfriedman@richardfriedmanlaw.com
www.richardfriedmanlaw.com
www.richardfriedmanlaw.com/blog
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Gearing Up to Comply With New York State’s and City’s New Anti-Sexual Harassment Laws by Richard Friedman

Gearing Up to Comply With New York State’s and City’s New Anti-Sexual Harassment Laws

As discussed in a previous newsletter, the #MeToo movement has generated nationwide discussion about sexual harassment and resulted in increased workplace sexual harassment complaints throughout the country. In response to the perceived growing crisis, New York State made extensive changes to the state’s human rights laws as part of the 2019 New York State Budget. In addition, the New York City Council passed the Stop Sexual Harassment in NYC Act. These changes increase employer liability for—and enhance employee protections against—workplace sexual harassment and gender discrimination, requiring the immediate attention of employers of all sizes. This article will discuss what I consider to be the most salient changes in the law.    

2019 New York State Law

The 2019 New York State Budget, signed into effect by Governor Andrew Cuomo, contains many employee-related changes of which employers should be aware, including:

1. Mandatory Annual Sexual Harassment Prevention Policy and Interactive Training Program 

Effective October 9, 2018, New York State employers must implement a new sexual harassment policy that meets or exceeds the guidelines provided by the forthcoming model sexual harassment prevention policy created by the New York State Department of Labor and New York State Division of Human Rights. Employers must distribute their new or revamped policies to all employees and provide a standard complaint form for employee use. 

Additionally, employers must implement an interactive sexual harassment prevention training program that features:

  • an explanation and specific examples of sexual harassment;
  • detailed information about federal, state, and local laws concerning sexual harassment and available remedies for victims;
  • the responsibilities of supervisors; and
  • a description of employee rights and all internal and external forums for bringing complaints.

Employers must conduct these trainings for all employees annually.

2. Prohibition of Mandatory Arbitration of Sexual Harassment Claims

Since July 11, 2018, New York Civil Practice Law and Rules has banned mandatory binding arbitration provisions in employment contracts except where inconsistent with federal law or included as part of a collective bargaining agreement. It is unclear whether this provision will withstand legal challenges asserting that the Federal Arbitration Act preempts it, but employers should operate under the assumption that it’s constitutionality will be upheld while awaiting word eventually from the Supreme Court.

3. Extension of Employer Liability for Sexual Harassment to Non-Employees

Since April 12, 2018, employers can be held liable for sexual harassment claims brought by non-employees such as independent contractors and subcontractors as well as employees working under service contracts. Employers will be liable for sexual harassment experienced by non-employees if the employer had knowledge or should have known about the incident(s) and did not take prompt and appropriate action to resolve the issue.

4. Prohibition of Non-Disclosure Agreements

Since July 11, 2018, New York State Law has prohibited non-disclosure provisions in sexual harassment settlement agreements unless the complainant consents. In order to obtain consent, the employer must ensure:

  • the complainant prefers a non-disclosure provision;
  • the complainant is given 21 days to consider the non-disclosure provision; and
  • the complainant is given seven days to revoke acceptance of the non-disclosure provision.

Stop Sexual Harassment in NYC Act (the”Act”)(New York City Law)

The passing of the Stop Sexual Harassment in NYC Act, many provisions of which became effective when Mayor De Blasio signed it on May 9, 2018, requires the attention of all NYC employers. The following is a list of provisions of which employers should be aware:

1. Extended Statute of Limitations for NYC Sexual Harassment Claims

The statute of limitations for sexual harassment claims under the New York City Human Rights Law was extended from one year to three years.

2. Law Applies to All Employers

Current city laws prohibiting gender-based harassment apply equally to all employers, rather than merely those with four or more employees.

3. Requirement to Distribute Written Policies, Forms, Information Sheets, and Hang Posters Outlining the Sexual Harassment Complaint Process

Effective September 7, 2018, 120 days after Mayor De Blasio signed the Act, New York City employers will be required to conspicuously display a poster created by the New York City Human Rights Commission that outlines the rights of employees and responsibilities of employers with respect to sexual harassment policies and protocol. Employers must also distribute an information sheet containing the same information to current employees and new employees upon hire.

4. Mandatory Interactive Anti-Sexual Harassment Training

Effective April 1, 2019, the Act requires employers with 15 or more employees to conduct annual, interactive anti-sexual harassment training with all employees and interns. According to the City Law, the “interactive” requirement means “participatory teaching whereby the trainee is engaged in a trainer-trainee interaction, use of audio-visuals, computer or online training program or other participatory forms of training as determined by the [New York City Human Rights] Commission.”

Though it is similar to the New York State law, the Act provides a longer list of mandates for the trainings and does not require training of employees until after 90 days of employment or retraining of employees who participated in the requisite training through another employer. Employers are now required to maintain training records dating back three years to demonstrate compliance with the law.

Takeaway

Given the extensive changes in New York State and New York City Law contained in these two pieces of legislation, it is reasonable to assume that there will be an upswing in sexual harassment claims against New York State and New York City employers. Accordingly, if not yet doing so, employers should implement policy and training reforms to their sexual harassment programs, if any, to protect their employees and try to insulate themselves from potential liability.  

Richard B. Friedman
Richard Friedman PLLC

830 Third Avenue, 5th Floor
New York, New York 10022
TEL: 212-600-9539
rfriedman@richardfriedmanlaw.com
www.richardfriedmanlaw.com
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Clawing Back All Compensation From the “Faithless Servant” Under New York Law by Richard Friedman

Clawing Back All Compensation From the “Faithless Servant” Under New York Law

In a terse opinion, the Appellate Division of the Supreme Court of New York, First Department recently unanimously affirmed an arbitration award in favor of legal recruiting firm Major, Lindsey & Africa, LLC (“MLA”) pursuant to which MLA was awarded almost $1.8 million in compensation paid to a former employee during her four-year tenure at the firm as well as over $900,000 in attorneys’ fees and costs on the grounds that the former employee had stolen trade secrets from the firm and had disclosed confidential information to certain of MLA’s competitors. Mahn v. Major, Lindsey & Africa, LLC, 2018 N.Y. Slip Op. 01888 (March 20, 2018). Applying the faithless servant theory of liability, the First Department found that the decision to claw back all salary and commissions paid to the employee during her four-year tenure with the firm did not violate New York’s public policy. The decision is the most recent confirmation that the faithless servant doctrine remains a viable basis for liability in New York and offers a potentially powerful tool for employers to use against employees who have been unfaithful even where, as discussed below, the employer cannot prove damages

The faithless servant rule is grounded in the law of agency and provides a tool that employers can use to claw back all compensation paid to a former employee upon demonstrating that the employee repeatedly engaged in disloyal and unfaithful conduct during the term of his or her employment. The theory underlying the doctrine is quite simple: one who has acted unfaithfully or in bad faith in an employment context should not be entitled to retain his or her compensation. 

The faithless servant doctrine was first recognized by the New York Court of Appeals in Murray v. Bear, 102 N.Y. 505 (1886). New York’s highest court found that “[a]n agent is held to uberrima fides [utmost fidelity] in his dealings with his principal, and if he acts adversely to his employer in any part of the transaction or omits to disclose any interest which would naturally influence his conduct in dealing with the subject of employment, it amounts to such a fraud upon the principal as to forfeit any right to compensation for services.” Id. at 508. 

Over 90 years after Murray was decided, the Court of Appeals affirmed the doctrine’s survival in New York and held that forfeiture of compensation is compulsory even when some or all of “the employee’s services were beneficial to the principal or when the principal suffered no provable damage as a result of the breach of fidelity by the agent.” Feiger v. Iral Jewelry, Ltd., 41 N.Y.2d 928, 928-929 (1977). Under the Court’s analysis, a faithless employee can be ordered to forfeit all compensation paid during the entire course of the employee’s disloyalty, irrespective of the employer’s ability to prove concrete damages or harm. 

The faithless servant doctrine has been applied in New York to two scenarios: (1) where the employee’s disloyalty and wrongdoing substantially violated his employment contract such that it saturated the employee’s work on the most material and critical level; and (2) where the employee’s unfaithful conduct constituted a breach of the duty of loyalty. Actionable misconduct under a faithless servant theory can take many forms such as fraudulent misconduct, gross negligence, embezzlement, misappropriating trade secrets, behavior detrimental to the company, or misstating a company’s financial position. 

The Major Lindsey arbitration decision was based on the arbitrator’s finding that, in addition to the former employee having stolen trade secrets, she had intentionally shared confidential job postings with certain of MLA’s direct competitors. Although critics of the faithless servant doctrine have characterized it as overly punitive, the First Department obviously feels differently. It upheld the arbitrator’s award totaling $2.7 million, which included disgorgement of over four years of prior salary and commissions paid to the employee in the amount of $1.77 million and over $900,000 in attorneys’ fees and costs. The Court specifically held that such award was not punitive in nature and did not violate New York’s public policy. 

By forcing disgorgement of all compensation paid to an employee during the course of his or her misconduct, the faithless servant doctrine provides employers with a more clear-cut and calculable basis for damages than breach of contract and tortious interference claims. Such claims require that a plaintiff demonstrate the monetary value of the damages suffered from the prior employee’s misconduct. This requirement can often be difficult to satisfy since the actual scope and degree of the misconduct may not yet be entirely clear. 

Under the faithless servant doctrine, by contrast, as long as the plaintiff can make a sufficient showing of disloyalty by the former employee during his or her employment, the plaintiff can seek recovery of all compensation paid to the employee over the course of such employment.  Disgorgement may be required even if the employer suffered no damages from the employee’s disloyalty because one of the primary purposes of this doctrine is to remove all incentive for a servant, i.e., employee, to be faithless. South Pierre Assocs. v. Meyers, 12 Misc.3d 955, 960-61 (Civ. Ct. N.Y. 2006). The penalty for violating the doctrine is harsh and can be draconian to some: the employee must forfeit all compensation earned since the first date of employment even though the employee’s services may have otherwise benefitted the employer and even if the employer suffered no damages

In Beach v. Touradji Capital Management, LP, 144 A.D.3d 557 (1st Dep’t 2016), for example, the court held that the faithless servant doctrine could be used to recover the compensation paid to disloyal employees who formed a competing company regardless of whether the counterclaim plaintiff could prove damages occurring from its loss of investors. Beach confirmed the faithless servant doctrine’s place as a potent weapon for employers faced with an employee engaged in disloyalty during his or her employment. Like Beach, in Major Lindsey, the plaintiff may have sustained some harm to its good will from the defendant’s disclosure of trade secrets to its competitors. Rather than attempt to calculate the value of that harm, the faithless servant doctrine provided MLA with a tool to claw back all compensation paid to the former employee during her four years of employment. 

The affirmation of the Major Lindsey arbitration award by the First Department is an obvious win for employers and should serve as a reminder that the powerful faithless servant doctrine is alive and well in New York. In addition, the case should serve as a warning to potentially disloyal employees: the penalty for future misconduct may be much more than they “bargained for.” 

Richard B. Friedman
Richard Friedman PLLC

830 Third Avenue, 5th Floor
New York, New York 10022
TEL: 212-600-9539
rfriedman@richardfriedmanlaw.com
www.richardfriedmanlaw.com
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Sexual Harassment Workplace Investigations in the #MeToo Movement Era* by Richard Friedman

Sexual Harassment Workplace Investigations in the #MeToo Movement Era*

Since the advent of the #MeToo Movement Era, anecdotal evidence suggests that there has been a spike in complaints of alleged sexual harassment in for-profit and non-profit companies throughout the country. It is now more important than ever that companies and other organizations deal with sexual harassment allegations head-on. This means investigating allegations promptly and thoroughly, protecting victims against retaliation, taking proper action when wrongful conduct is found to have occurred, and taking steps to try to prevent future harassment. This article will identify some best practices in this regard.  

What to Do When Harassment Claims Arise

One of the best ways of dealing with sexual harassment allegations is to address them in a timely manner. Organizations should implement a regimen pursuant to which managers at all levels are trained to identify inappropriate behavior and follow the established protocols for escalating issues for investigation. In almost any organization, written policies should require that harassment complaints be brought to the Human Resources or Compliance Departments or to an Ombudsman.

Commencing an Investigation: Determining Appropriate Goals, Authority, and Scope

Investigations of sexual harassment claims should be prompt, efficient, thorough, and fair and balanced. An investigation’s general focus and its goals depend in large part on timing. If it occurs pre-dispute, the investigation generally takes on a preventative focus; during the dispute, a fact-finding focus; post-dispute, a focus on what went wrong and how to try to prevent it from recurring.

In determining who would be appropriate to lead an investigation, it is essential that the choice be impartial, i.e., that the chosen investigators have no actual or perceived conflict of interest. The investigators should be credible, respected, and knowledgeable about company policies and, if feasible, relevant laws. Since a knowledge of employment law can be very helpful, in-house counsel and sometimes outside counsel are good choices for investigations of senior personnel at a minimum. In large organizations, routine investigation of lower level personnel is sometimes undertaken by a department devoted to that function.

The scope of an investigation is fact-specific and determined in large part by what it seeks to uncover. Initially, the investigation’s scope depends upon the nature of the complaints, but the scope may change as facts come to light. In some cases, an investigation may ultimately center on the credibility of the alleged harasser or that of the alleged victim; in others, it may develop into a systemic examination of the company’s or organization’s processes and practices.

Though an investigation will not always run according to course, a preliminary investigative plan is necessary. It should include: 

  • a description of the known facts and specific issues to be explored;
  • lists of individuals who may have relevant information and known or possible documentary evidence; and
  • a proposed timeline.

Handling Evidence and Witness Testimony

The following considerations apply to the handling of evidence in sexual harassment investigations. First, investigators must explore all types of evidence. Relevant information includes records of prior applicable complaints, witness interviews, personnel files, performance evaluations, compensation records, timekeeping records, emails, texts, voicemails, audio/video recordings, employee notes/logs, and background checks.

This information should be gathered and documented with care. Investigators should assume that all documentation and notes are discoverable. Therefore, all notes should be detailed, fact-based, accurate, and complete. They should not be destroyed upon completion of the investigation.

In selecting witnesses, the investigators must assess witness credibility before and after the interviews. One factor that should be considered in determining the credibility of testimony is the anxiety level of the witness (an anxious witness could lead to a spotty or exaggerated account of important events and information).

Investigators should generally not allow counsel or other representatives of witnesses to attend witness interviews. However, there are several possible exceptions to this general advice. Where the legal rights of a witness are implicated or where the employee has engaged in a workplace rules violation and holds an objectively reasonable belief that he or she faces discipline, it may be appropriate to allow a representative to attend. See NLRB v. Weingarten, 420 U.S. 251 (1975) (finding that employee was entitled to union representation where such factors were present). However, the lawyer or other representative should be told that she will be excluded if she disrupts the interview or answers questions on behalf of the witness.

Confidentiality and Privilege Issues

Despite the preferences of many employers for confidentiality, disclosure may be required by statute or administrative guidance. In Banner Health Systems, 362 NLRB No. 137 (June 26, 2015), the National Labor Relations Board (“NLRB”) disapproved of employers directing employees to keep information related to internal investigations confidential. The NLRB held that employers violate their employees’ rights under Section 7 of the National Labor Relations Act (“NLRA”) when they require or request their employees to keep interviews conducted as part of an internal investigation secret from other employees. An exception applies if the employer can clearly demonstrate “that confidentiality was necessary to maintain the integrity of any particular investigation or any particular interview.” But the Banner Health decision demands that employers be cautious of any categorical confidentiality policy.

Understanding the scope of the attorney-client privilege is critical to ensuring maximum confidentiality in any workplace investigation, including investigations of sexual harassment. The attorney-client privilege will apply if all of the following elements are present and asserted: a) a communication b) made in confidence c) to an attorney d) by a client e) for the purpose of seeking or obtaining legal advice. See Upjohn Co. v. United States, 449 U.S. 383 (1981).

In the context of workplace investigations, the attorney-client privilege protects communications between agents of an organization and the organization’s attorney(s). That privilege does not extend to third parties. Communications between in-house and external counsel are generally considered privileged unless the work performed by counsel is construed as having been performed as a fact-finder rather than as an attorney. Likewise, communications between counsel and the Human Resources Department are privileged unless the communications are construed as business, rather than legal, discussions.

With these potential pitfalls in mind, attorneys should include legal analysis in all interview memoranda so courts are less likely to see their work as unprivileged fact-finding and more likely to see it as privileged lawyering.

Preparing Investigative Reports

Summary reports should be prepared at the preliminary and interim stages of the investigation. They should include details regarding the complaint or event that prompted the investigation, including names and departments of any complainants or victims, the issues investigated, factual findings on each issue, and key facts supporting findings made. An investigation timetable from inception, including interviews conducted and other investigatory steps taken, may also be useful. Summary reports will serve as an introduction to decision makers seeking to determine, among other issues, whether and the extent to which remedial action should be taken.

A report of the findings should also be made at the conclusion of the investigation. It should include, in addition to information obtained from the witness interview memoranda, a summary of the critical information learned throughout the investigation, the identification of any injury, and recommendations made by the investigator(s).

Clear, accurate, and thorough reporting is especially important if the complainant ultimately brings suit, not only because it preserves evidential findings relevant to litigation, but also because it may help the company or organization maintain the Farragher/Ellerth affirmative defense. The Supreme Court articulated the defense in Faragher v. Boca Raton, 524 U.S. 775 (1998), and Burlington Industries, Inc. v. Ellerth, 524 U.S. 742 (1998), and it is available against claims under the Civil Rights Act of 1964 if an employer can prove:

  1. that the employer exercised reasonable care to prevent and correct promptly any sexually harassing behavior; and
  2. that the plaintiff employee unreasonably failed to take advantage of any preventive or corrective opportunities provided by the employer or to avoid harm otherwise.

Thus, summary reports and reports of the findings are essential to the employer’s use of the Farragher/Ellerth defense because they help show that the employer conducted the investigation promptly, thoroughly, and without bias.

Taking Remedial Action

When convincing evidence of harassment has been uncovered, employers should take remedial action against the harasser. Doing so fosters a zero-tolerance culture that is now widely regarded as necessary to a harassment-free workplace. See, e.g., Ask Aliya: Building a Work Culture that Prevents Sexual Harassment.” Potential remedial actions include:

  • termination of employment;
  • suspension without pay;
  • a warning or reprimand letter;
  • demotion;
  • requiring the harasser to forgo or give back discretionary compensation (bonus);
  • reissuing anti-harassment and anti-retaliation policies to the alleged harasser; and
  • requiring training for the harasser, the department, or the entire organization.

Any remedial actions should be documented as described above.

Minimizing the Risk of Retaliation Claims

In order to prevent future retaliation claims, companies and organizations must maintain a strict anti-retaliation policy. The subject of the investigation and all employees involved should be warned that retaliation is prohibited. All complaints should be initially treated equally, even though every complaint may not ultimately evolve into a full-fledged investigation. The equal treatment of complaints must apply regardless of the alleged victim’s position in the company or organization or the history of complaints, i.e., every complaint must be treated as if it were the first. Most importantly, investigators and management should never ask the complainant(s) to withdraw the complaint, express concern about how the complaint(s) will affect the company, or threaten the complainant(s). 

*This article will not address the changes in New York State law which went into effect on April 12, 2018 when Governor Cuomo signed the 2019 New York budget into law which, among other things, obligates New York employers to (i) distribute a written sexual harassment policy and (ii) perform annual sexual harassment training. Nor does the article address the “Stop Sexual Harassment in NYC Act” which was signed into law by Mayor de Blasio on May 9, 2018 and, among other things, extends the New York City Human Rights Law’s sexual harassment protections to all workers, including those at employers with fewer than five employees (which were previously exempt). Those laws will likely be the subject of an upcoming newsletter.

Richard B. Friedman
Richard Friedman PLLC

830 Third Avenue, 5th Floor
New York, New York 10022
TEL: 212-600-9539
rfriedman@richardfriedmanlaw.com
www.richardfriedmanlaw.com
www.richardfriedmanlaw.com/blog
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Restrictive Covenants in Franchise Agreements Under New York Law by Richard Friedman

Restrictive Covenants in Franchise Agreements Under New York Law

What Are They?

Restrictive covenants are often found in agreements between franchisors and franchisees. The purpose of such covenants is to prevent franchisees—who are the owners and operators of businesses such as “chain-style” stores and restaurants—from harming franchisors by providing similar goods or services after the franchise agreement expires or is terminated. Restrictive covenants can serve to protect the good will of the franchisor after the franchise is reconveyed. See Jiffy Lube Int’l, Inc. v. Weiss Bros., 834 F. Supp. 683, 691 (D.N.J. 1993). 

A typical restrictive covenant clause in a franchise agreement provides that the franchisee may not own or operate a similar or competing entity in a specified area for a specified period of time after the franchise relationship expires or is terminated. 

When Are They Enforceable? 

In order to be enforceable in New York, restrictive covenants in franchise agreements must be:

1. reasonable in geographical and temporal scope; and

2. necessary to protect a franchisor’s legitimate interest. 

ServiceMaster Residential/Commercial Servs., L.P. v. Westchester Cleaning Servs., Inc., No. 01 CIV. 2229 (JSM), 2001 WL 396520, at *3 (S.D.N.Y. Apr. 19, 2001). 

In determining whether to grant an injunction to enforce a restrictive covenant, New York courts weigh the harm that such an injunction would likely cause to the franchisee and to the general public. Golden Krust Patties, Inc. v. Bullock, 957 F. Supp. 2d 186, 198 (E.D.N.Y. 2013) (citing BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 389, 690 N.Y.S.2d 854, 712 N.E.2d 1220 (N.Y.1999). 

New York courts have held franchise agreements akin to employment agreements. Am. Jur. 2d, Monopolies, Restraints of Trade, and Unfair Trade Practices §§ 511-521. Accordingly, the general rules and policies that govern restrictive covenants in employment agreements also apply in courts’ analyses of such covenants in franchise agreements. Id. We have written recently on the current state of restrictive covenants under New York law. That article can be found here

1) Reasonable in Geographical and Temporal Scope 

Under New York law, a restrictive covenant will be found enforceable where it is reasonable in geographic and temporal scope. Golden Krust Patties, Inc. at 198. Whether geographic and temporal scope is reasonable is acutely fact specific. Courts recognize franchisors’ interests in preventing ex-franchisees selling to customers of the former franchise, thereby profiting from and potentially damaging the franchisor’s good will. See ServiceMaster Residential/Commercial Servs., L.P. v. Westchester Cleaning Servs., Inc., No. 01 CIV. 2229 (JSM), 2001 WL 396520, at *3 (S.D.N.Y. Apr. 19, 2001); Carvel Corp. v. Eisenberg, 692 F.Supp. 182, 185–86 (S.D.N.Y.1988) (restriction against competing stores within two miles for three years was “reasonably related to Carvel’s interest in protecting its know-how and to its ability to install another franchise in the same territory”). However, courts will not enforce restrictions regarding when and where a former franchisee can compete when such restrictions are found to be overbroad and detrimental to the franchisee’s ability to earn a livelihood. 

In Singas Famous Pizza Brands Corp. v. New York Advertising LLC, 468 F. App’x 43 (2d Cir. 2012), the Second Circuit held that a restrictive covenant that prohibited a former pizza store franchisee from engaging in “the Italian food service business” within ten miles of the franchisee’s former location for a two-year period was reasonable. The Court based its conclusion on evidence that it had taken four years for the former franchisee to find a suitable location for the Singas. The Court also stated that the ten-mile geographical restriction was “reasonably calculated towards furthering [the franchisor’s] legitimate interests in protecting its ‘knowledge and reputation’ as well as its ‘customer goodwill.’” See Id. at 46–47. 

However, the court reached a somewhat different result in Golden Krust Patties, Inc. v. Bullock. In that matter, Golden Krust, a Caribbean fast-food chain, sought a preliminary injunction against a former franchisee whose franchise agreement was terminated after the franchisee was discovered to have been selling food products manufactured by Golden Krust’s competitors. The franchise agreement stated that, for two years after expiration or termination of the agreement, Golden Krust franchisees were restricted from opening any restaurant at or within ten miles of the franchise location, or within five miles of any other Golden Krust in operation or under construction.

The Eastern District Court ultimately granted the injunction but modified the geographic constraints of the non-compete provision to reflect “the densely populated nature of the New York Metropolitan area.”  Golden Krust Patties, Inc. at 199 (E.D.N.Y. 2013). Reasoning that “most consumers in that region will not travel ten miles—or even five miles—to a fast-food establishment,” the Court determined that a four-mile restriction from the franchise location was more appropriate than the original ten-mile restriction. Id. Additionally, the Court reduced from five miles to two and a half miles the required minimum distance of restaurants that could be opened by the former franchisee from any Golden Krust location. The Court cited the close proximity between Golden Krust locations (often less than one mile apart) as evidence that a broad non-compete zone was not necessary. Id. 

The Golden Krust Court distinguished the case from Singas, holding that Singas had only restricted franchisees from operating Italian food service businesses, whereas Golden Krust restricted former franchisees from operating any type of restaurant business. Id. It is reasonable to believe that the court would have been less inclined to modify the geographic scope of the non-compete had Golden Krust restricted franchisees only from serving Caribbean-style food. Thus, one major takeaway from these cases is that New York courts are more likely to find temporal and geographic restrictions to be reasonable if a franchise agreement’s non-compete clause is sufficiently narrow in other ways. 

2) Legitimate Business Interests 

New York courts have traditionally required that restrictive covenants in franchise agreements, in addition to being reasonable in time and scope, serve legitimate business interests. ServiceMaster Residential/Commercial Servs., L.P. at *3. As already noted above, courts recognize in franchisors a legitimate interest in guarding against former franchisees’ exploitation of i) the knowledge provided by the franchisor and ii) the franchisor’s customer base. In ServiceMaster Residential, the Court held there to be “a recognized danger that former franchisees will use the knowledge that they have gained from the franchisor to serve its former customers, and that continued operation under a different name may confuse customers and thereby damage the good will of the franchisor.” ServiceMaster Residential/Commercial Servs., L.P at *3 (citing Jiffy Lube Int’l, Inc. v. Weiss Bros., Inc., 834 F.Supp. 683, 691-92 (D .N.J.1993) (upholding ten-month, five-mile restriction on rapid lube operation); Economou v. Physicians Weight Loss Ctrs., 756 F.Supp. 1024, 1032 (N.D.Ohio 1991) (upholding one-year, fifty-mile restriction on diet center). 

Legitimate business interests are strengthened when the franchisor has provided the franchisee with unique access to training and clientele. In finding that ServiceMaster’s restrictive covenant served a legitimate interest, the Court emphasized that the franchisor had provided the franchisee with training and confidential manuals regarding how to launch a restoration cleaning business. ServiceMaster Residential/Commercial Servs., L.P at *3. 

Likewise, in RESCUECOM Corp. v. Mathews, No. 5:05CV1330 (FJS/GJD), 2006 WL 1742073, at *1 (N.D.N.Y. June 20, 2006), the Court found that the franchisor-plaintiff had provided the former franchisee with “training and manuals pertaining to the best methods for operating a successful computer sales and services business . . . [and] extended to the defendant the knowledge and ability to launch and successfully operate a computer sales and services business.” The franchisor had also provided the franchisee with access to clientele, evidenced by the fact that the franchisee successfully diverted at least five of the franchisor’s former customers. Id. at *2. The Court granted a preliminary injunction against the defendant, who had opened a computer sales company in the same location as the franchise he had previously operated. 

3) Weighing the Interests of the Franchisee and the Public 

In determining whether to grant injunctions based upon the restrictive covenants of franchise agreements, recent cases have emphasized the balancing of the franchisor’s interests against the interests of both the public and the franchisee. See Singas Famous Pizza Brands Corp. at *12; Golden Krust Patties, Inc. at 198. 

Singas and Golden Krust—two of the most recent leading New York decisions involving restrictive covenants in franchise agreements—explicitly consider the potential harm of enforcing the non-compete provisions at issue to both the former franchisees and the public interest. Both decisions ultimately found the covenants enforceable and granted injunctions (though the Golden Krust Court, as discussed above, modified the temporal and geographic scope of the provision). 

In Singas, the Court acknowledged that defendants invested significant time and money into restaurants they had hoped would be Singas franchises. However, according to the Court, “any hardship caused by an injunction was caused by the defendants’ own violation of the Agreement” when they opened a restaurant location as a purported franchise without having received permission from Singas. Singas Famous Pizza Brands Corp. at *12. 

In Golden Krust, the Court also found that any harm caused to defendants by an injunction would stem from their own wrongdoing, as the former franchisee had sought to pass off a competitor’s product as a Golden Krust product, and had continued to operate after termination in contravention of the franchise agreement. Golden Krust Patties, Inc, at 199–200. In addition, the Golden Krust Court found that the public would be harmed if the defendants were allowed to continue to use the franchisor’s trademarks and solicit Golden Krust customers. The Court stated as follows: “There is likely a greater harm to the public in the form of consumer confusion if defendants are not enjoined.” Golden Krust Patties, Inc. at 200. 

Conclusion 

The general rules and policies that govern restrictive covenants in employment agreements also apply in New York courts’ analyses of such covenants in franchise agreements. However, courts will give deference to franchisors which have provided unique access to training and other benefits to franchisees. Thus, as with such cases in the employment context, litigations involving the alleged breach of restrictive covenants in franchise agreements are very factually intensive and are best handled by counsel who regularly represent clients in such matters.

Richard B. Friedman
Richard Friedman PLLC

830 Third Avenue, 5th Floor
New York, New York 10022
TEL: 212-600-9539
rfriedman@richardfriedmanlaw.com
www.richardfriedmanlaw.com
www.richardfriedmanlaw.com/blog
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Current State of Restrictive Covenants Under New York Law by Richard Friedman

Current State of Restrictive Covenants Under New York Law

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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Trade Secret Litigation: The Inevitable Disclosure Doctrine in New York: Alive or Dead? by Richard Friedman

Trade Secret Litigation: The Inevitable Disclosure Doctrine in New York — Alive or Dead?

In my September 15 article, I identified certain steps that companies seeking and defending against preliminary injunction motions under the Defend Trade Secrets Acts of 2016 (“DTSA”) should consider. We left the discussion of whether the inevitable disclosure doctrine could be relied upon when seeking a preliminary injunction for a later day. Today is that day.

The Basics

Where applicable, the inevitable disclosure doctrine allows a plaintiff company to establish a claim of trade secret misappropriation by demonstrating that a former employee’s prospective or new job will inevitably lead him to disclose the plaintiff’s trade secrets to his future or new employer or to rely on such information even where there is no evidence of actual disclosure. The underlying justification is that, once proprietary information is obtained, it is virtually impossible for a person to not use such information in a subsequent similar position. If a former employee who holds knowledge of trade secrets is hired by a competitor for a similar position, courts that have adopted the inevitable disclosure doctrine have considered such facts sufficient to find threatened or actual misappropriation and have enjoined the prospective or new employer from employing the person in a position similar to the one he previously had.

The factors courts have considered in determining whether to apply the inevitable disclosure doctrine include:

1. the level of competition between the past employer and the new employer;

2. whether the former employee’s prospective or new position with the new employer is similar to his former position; and

3. the steps that the new employer has taken to prevent the employee’s reference to and use of trade secrets belonging to the prior employer.

State courts have had mixed reactions to the doctrine’s application. While it has been accepted by courts under state trade secret law in several jurisdictions such as New Jersey, Delaware, and Illinois, other states – including Maryland, California, and Florida, to name a few – have explicitly rejected the doctrine, typically to safeguard employee mobility.

There are legitimate policy considerations that fall on both sides of the debate over the inevitable disclosure doctrine. On the one hand, application of the doctrine could be seen as essential to protect the confidentiality of trade secrets that companies have a genuine right to protect and an interest in protecting. On the other hand, the doctrine may serve to constrain valuable economic productivity and prevent someone from doing what he does best, and therefore prevent him from achieving his income potential without any actual evidence of bad faith or misconduct on his part.

The Doctrine’s Origins and Heyday in New York

Inevitable disclosure is not a new doctrine. In New York, its origins date back almost one hundred years to Eastman Kodak Co. v. Powers Film Products, Inc., 189 AD. 556 (4th Dep’t 1919). The doctrine’s heyday was in the 1990s as demonstrated by the decisions in Lumex, Inc. v. Highsmith, 919 F.Supp 624 (E.D.N.Y. 1996) and DoubleClick, Inc. v. Hendersen, 1997 WL 73143, at *4 (N.Y. Co. Ct. Nov. 7, 1997). In Lumex, the United States District Court for the Eastern District of New York concluded that the doctrine was sufficient to offer the missing evidence of actual proof of use of trade secrets on a preliminary injunction motion simply because a former employee had signed a noncompete agreement, even in a situation in which the departing employee acted with genuine good faith. In DoubleClick Inc., the New York State Supreme Court in New York County held that, even in an instance where there was no noncompete agreement, when the departing employee had left with physical or electronic data files, the employee’s inevitability of use or disclosure of trade secrets was demonstrated by the already established misconduct.

The Doctrine Falls Out of Favor in New York

The decisions in these two cases reflected an accepting approach to the inevitable disclosure doctrine by New York courts. That did not last long. The doctrine quickly withdrew from its peak when employers began to use it as an alternative to a noncompete agreement. In Earthweb v. Schlack, 71 F.Supp 2d 299 (S.D.N.Y. 1999), for example, the employer attempted to enjoin a former employee from taking a position with a competitor even though the parties’ agreement did not contain a noncompete provision. The U.S. District Court for the Southern District of New York held that, absent actual evidence of misappropriation of trade secrets, the inevitable disclosure doctrine could not be applied to recognize a de facto noncompete agreement and prevent an employee from accepting the new job altogether.

International Business Machines Corp. v. Visentin

International Business Machines Corp. v. Visentin2011 WL 672025 (S.D.N.Y. Feb. 16, 2011) provides a relatively recent example of a situation in which a New York federal court refused to find that a former senior executive would inevitably use or disclose the former employer’s trade secrets. The court recognized that the inevitable disclosure doctrine could be used as the grounds upon which an injunction may be granted in the proper context. However, after a lengthy analysis of the employee’s responsibilities in his former position, the nature of the purported confidential trade secrets, and the alleged reasons why the former employee would inevitably use or disclose trade secrets to his new employer, the court denied the motion for a preliminary injunction.

IBM senior executive Giovanni “John” G. Visentin had declared his intention to resign to accept a position working for Hewlett-Packard Company (“HP”). Despite Visentin’s offer to remain at IBM for a transition period, IBM rejected his offer and immediately retrieved Visentin’s laptop from his home. The next day, it filed a complaint against Visentin for breach of contract and misappropriation of trade secrets and sought for a preliminary injunction. At the end of a four-day hearing, the court denied IBM’s motion.

Visentin had entered into a noncompete agreement with IBM which provided that he would not work for a competitor for one year after the cessation of his employment at IBM. The court in Visentin stated that Visentin’s efforts to act in ‘good faith’ reduced the likelihood that his employment at HP could risk harm to IBM. For instance, Visentin’s commitment not to take any documents electronically or otherwise from IBM and to provide HP with a list of clients for whom he was banned from working supported his claims that he had no intention of using or disclosing any of IBM’s confidential information. Visentin’s demonstrated good faith in his resignation essentially provided the court with the basis to conclude that he would not ultimately be motivated to violate his agreement or break the law.

Free Country Ltd. v. Drennen 

In Free Country Ltd. v. Drennen, 2016 WL 7635516 (S.D.N.Y. 2016), decided in December of 2016, the U.S. District Court for the Southern District of New York refused to use the inevitable disclosure doctrine to prevent a departing employee from soliciting customers using his former employer’s “Master Contact List” for its clients in his new position at a competitor in the absence of a proper noncompete agreement.

The DTSA has spurned the use of the inevitable disclosure doctrine as a means of preventing an employee from accepting a new employment offer. While the DTSA provides for injunctive relief to be granted to prevent threatened or actual misappropriation of trade secrets, any conditions placed on a person’s employment in an injunction must be based on “evidence of threatened misappropriation and not merely on the information that the person knows.”

Practical Pointers: How, if at all, can a New York employer use the inevitable disclosure doctrine to protect itself from competition from former employees who have knowledge of trade secrets?

The cases discussed above provide several valuable instructions for both employers seeking to maintain the confidentiality of their trade secrets and those who wish to extend-hire personnel from competitors for similar positions.

At the risk of stating the obvious, a narrowly drafted noncompete agreement is the most effective way to prevent misappropriation of trade secrets. In such situations, the inevitable disclosure doctrine can be invoked to bolster an employer’s motion for a preliminary injunction in reliance on the noncompete provision. The narrower the scope of the noncompete provision, the more likely most courts will be to enforce it as drafted.

To maximize the likelihood of successfully enjoining a former employee, a noncompete provision should, if possible, explicitly list the competitors by whom the employee is barred from accepting a job offer working in the same or a comparable capacity and/or explicitly list clients whose solicitation is prohibited. It would be beneficial for an agreement to include a provision specifying that the employee would inevitably use or disclose confidential information if he were to work for one of the specified competitors or solicit a particular client. A departing employee, especially one with access to legal counsel to review and negotiate the noncompete agreement, would likely find it extremely difficult to successfully later challenge the terms to which he explicitly accepted.

When an employee announces his intent to accept a new position working for a competitor, employers should avoid acting prematurely, because such a response may encourage a court to find that the former employer has acted spitefully in an effort to punish the departing employee. In Visentinfor example, IBM failed to create a record showing that it had acted prudently, consciously, and purposefully in the interests of protecting its trade secrets and not punitively to punish Visentin or HP.

On the converse, companies should make demonstrated efforts to ensure that any employee hired from a competitor refrains from taking any electronic or other confidential information from his former employer to minimize any appearance that the employee plans to use or disclose trade secrets of the former employer in his new position. The hiring employer and the departing employee should document and implement safeguards in order to try to avoid misappropriation of trade secrets, such as client lists, so that they can demonstrate those safeguards in any future litigation that may result.

Where possible, which will not always be the case, an employer should devote time and effort to structure a new employee’s position to reduce the probability that it appears to be in substantial conflict with the employee’s position at his former employer, if it is a competitor.

Going Forward

Employers are encouraged to utilize narrowly constructed noncompete agreements for a relatively limited group of valuable employees whose resignation could cause harm to the company’s genuine business interests. Given the fact-intensive application of the inevitable disclosure doctrine, employers cannot derive universally applicable one-size-fits-all instructions to ensure the protection of trade secrets or to avoid violating the noncompete agreements of a competitor. Both Visentin and Free Country, however, provide meaningful guidance as to ways in which the equities, taken in the aggregate, can influence a court’s application of the doctrine. While New York courts no longer invoke the doctrine to create a de facto noncompete provision, the inevitable disclosure doctrine can still be an effective tool in a company’s arsenal while seeking to enforce a noncompete agreement.

Moreover, while a court cannot enjoin an individual based on inevitable disclosure under the DTSA, a trade secret owner may nevertheless allege inevitable disclosure in a complaint under the DTSA, along with relevant facts, and, if the complaint withstands a motion to dismiss, proceed with discovery, which could eventually reveal additional evidence needed to fully validate the claim.

Richard B. Friedman
Richard Friedman PLLC

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A Few Tips When Filing (and Opposing) a Preliminary Injunction Motion to Protect Trade Secrets by Richard Friedman

A Few Tips When Filing (and Opposing) a Preliminary Injunction Motion to Protect Trade Secrets

The Defend Trade Secrets Act of 2016 (the “DTSA”) is a federal statutory vehicle that companies can use to try to protect their most valuable assets (along with their employees, hopefully) — their trade secrets. Since the DTSA is only slightly more than a year old, there have been relatively few federal court decisions addressing the scope and breadth of the statute. One such case decided this summer in the Northern District of Illinois, Cortz, Inc. v. Doheny Enterprises, Inc., 2017 WL 2958071 (N.D. Ill. 2017), sheds light on the type of information afforded protection under the DTSA. The decision also offers insight as to how a plaintiff can improve its chances of securing a preliminary injunction at a misappropriation hearing under the DTSA as well as under state law and how a company defendant can attempt to defeat that motion.

In Cortz, plaintiff Cortz, Inc., a seller of swimming pool and spa products, initiated a suit against a former employee, Tim Murphy, and his new employer, Doheny Enterprise Inc., and sought a preliminary injunction prohibiting Murphy from continuing to work at Doheny. Among Cortz’s allegations were that Murphy possessed information about the prices that Cortz paid its vendors.

Cortz’s preliminary injunction motion was denied. The case provides us with at least three key takeaways vis-à-vis trade secret preliminary injunction motions.

First: Identify the Alleged Trade Secret with Particularity and Not Just a Body of Information in Which a Secret May Lie.             

Cortz alleged in its complaint that “financial information” had been misappropriated. Although the DTSA includes in its definition of trade secret “financial information” and “financial data,” the Illinois District Court held that a mere allegation of misappropriated “financial information” was insufficient under the DTSA. Instead, the Court stated, a plaintiff must allege “‘concrete secrets.’” Cortiz, Inc., quoting Composite Marin Propellers, Inc. v. Van Der Woude, 962 F.2d 1263, 1266 (7th Cir. 1993) (per curiam). 

During the hearing, Cortz introduced evidence that Murphy had access to pricing as to its 20,000 (!) different products with respect to its approximately 400 vendors and that vendor pricing is relevant for about two to three years. Cortz also introduced evidence that this price list was unique to Cortz even though its competitors purchased similar or identical products from the same vendors since specific retailers often negotiate their own prices with suppliers. Because Cortz had clarified that this was the specific information it was alleging to be a trade secret, the Court stated that it was prepared, for argument’s sake, to assume that Cortz had satisfied the particularity requirement under the DTSA.

The Court reached that conclusion despite stating that the facts that Cortz (i) had required vendors to sign an agreement containing a confidentiality clause and (ii) had entered into non-disclosure agreements with Doheny and Murphy while discussing a potential sale to Doheny (which obviously never went through) was insufficient to prove that it had adequately protected its trade secrets. Specifically, the Court stated, Cortz had failed to show, among other things, “the amount of time, effort, or money that it expended in developing its vendor pricing nor whether it would be difficult to duplicate its effort in doing so.”

As summarized below, Cortz’s failure to present admissible and credible evidence that the defendants had misappropriated its trade secrets was fatal to its preliminary injunction motion.

Second: Since the Rules of Evidence Apply at the Preliminary Injunction Stage, It Is Critical that Evidence of Misappropriation Falls within Applicable Rules.

At the risk of stating the obvious, the rules of evidence apply in preliminary injunction hearings. Thus, plaintiff’s counsel must ensure that the evidence it presents at the hearing is not only persuasive but admissible. During the hearing in Cortz, for example, the Court determined that certain third-party testimony was inadmissible hearsay because it was offered for the truth of the matter asserted and did not fall within a hearsay exception.

Of course, it is not enough for evidence to be admissible. It must also be credible and relevant. In Cortz, the Court found that there was no credible evidence that Murphy physically took any documents from his former employer, much less trade secret information, and that any vendor pricing information he remembered from his prior employment would be stale and irrelevant. Thus, the Court held that Cortz had failed to present admissible, credible, and relevant evidence to support its misappropriation claims. 

At the risk of also stating the obvious, plaintiff’s counsel in a trade secrets misappropriation case, as in all cases, must:

•  vet witnesses by assessing their credibility;

•  ensure that evidence can be introduced for an admissible purpose; and

•  determine whether the evidence at hand would further the plaintiff’s cause in court or is likely to be deemed irrelevant to the specific claims at hand.

Third: There Must Be Admissible, Credible Evidence of Actual, Not Merely Hypothetical, Misappropriation.

The Cortz Court pointed out that “it is well-established…that an ‘employer’s fear that its former employee will use the trade secrets in his new position is insufficient to justify application of the inevitable disclosure doctrine.’” Cortz, Inc., quoting Triumph Packaging Grp., 834 F. Supp. 2d 796, 809 (N.D. Ill. 2011). Among other evidentiary deficiencies, Cortz was not able to offer credible evidence that Murphy occupied the same or a similar function at Doheny as he had at Cortz. Further, Cortz’s contention that Murphy would inevitably disclose the supposed trade secrets was rejected because it was unable to demonstrate that he had in fact done so. The Court held that a preliminary injunction would not be granted in reliance on the much maligned so-called inevitable disclosure doctrine. (This doctrine is likely to be the subject of a future article.)

In conclusion, it is important for companies to consult counsel concerning steps that should be taken to try to ensure the protection of information that they consider to be trade secrets long before litigation is commenced. To be most effective, this advice must include an analysis of the particular jurisdiction’s requirements for treatment of information as legally protectable trade secrets in addition to requirements under the DTSA. Similarly, companies defending against misappropriation of trade secret claims under the DTSA should view Cortz as a good starting point for formulating their defenses against such claims at the all important preliminary injunction phase where these cases are often resolved.

Richard B. Friedman
Richard Friedman PLLC
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Are Non-Compete Provisions Enforceable in New York When the Employee is Terminated Involuntarily Without Cause? by Richard Friedman

Enforceability of Non-Compete Provisions in NY When Involuntary Termination Is Without Cause

A question that is or should be important to employers and employees alike is whether non-compete provisions in an employment agreement can be enforced in New York when the employee is terminated involuntarily without cause. As is well known, the law regarding restrictive covenant provisions such as non-competes is a matter of state law. Although disfavored in the typical employment context under New York law on the grounds that they interfere with a person’s right to earn a living, non-compete provisions are enforced if the terms are:

  1. no greater than required to protect an employer’s legitimate protectable interests and
  2. reasonable in temporal and geographic scope.

See Johnson Controls, Inc. v. A.P.T. Critical Sys. Inc., 323 F.Supp. 2d 525,533 (S.D.N.Y. 2004).

Some New York courts have concluded that non-compete clauses are per se unenforceable when the employee in question was terminated involuntarily without cause. However, other courts have concluded that this is not necessarily so. A Court of Appeals decision often cited to support both of these conclusions is Post v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 48 N.Y. 2d 84, rearg. denied, 48 N.Y.2d 975 (1979). In that matter, two employees who were involuntarily terminated without cause by Merrill Lynch subsequently joined a competing firm. Having agreed to forfeiture-for-competition clauses in their agreements with Merrill Lynch, the employees were told fifteen months after their termination that, pursuant to a provision of the firm’s pension and profit sharing plan which permitted forfeiture if an employee directly or indirectly competed with the firm, their accrued pension benefits had been revoked. The Court of Appeals, New York’s highest court, held that such a forfeiture-for-competition clause was unenforceable where an employee had been discharged without cause, stating that “[an] employer should not be permitted to use offensively an anti-competition clause coupled with a forfeiture provision to economically cripple a former employee and simultaneously deny other potential employers his services.” 48 N.Y.2d at 89.

As mentioned, New York courts have interpreted Post inconsistently. Some have applied it to all non-compete agreements and others have applied its rule more narrowly, i.e., only to forfeiture-for-competition clauses in a context where the employee was terminated without cause. For example, the Second Department and at least three judges in the Southern District of New York have similarly ruled that Post stands for the proposition that non-compete clauses are categorically precluded from enforcement when an employee has been involuntarily discharged without cause. See, e.g., Grassi & Co., CPAs, P.C. v. Janover Rubinroit, LLC, 82 A.D.3d 700 (2d Dep’t 2011); Arakelian v. Omnicare, Inc., 735 F. Supp. 2d 22 (S.D.N.Y. 2010).

Other New York courts have ruled that Post does not stand for a per se rule applicable to all restrictive covenants. Most notably, in Morris v. Schroder Capital Management International, 7 N.Y.3d 616, 621 (2006), the Court of Appeals itself, citing Post, stated that “a court must determine whether forfeiture is ‘reasonable’ if the employee was terminated involuntarily without cause.” See also Hyde v. KLS Professional Advisors Group, LLC, 500 Fed.Appx. 24 (2d Cir. 2012); Brown & Brown, Inc. v. Johnson, 115 A.D.3d 162 (4th Dep’t 2014), rev’d on other grounds, 2015 WL 3616181 (2015).

In Hyde, the Second Circuit concluded that Post should be interpreted narrowly, cautioning that the Court of Appeals addressed only a forfeiture-for-competition clause in that matter, and that the district court should not “[extend] Post beyond its holding.” 500 Fed.Appx. 24 at 26.

In Brown, Justice Whalen of the Fourth Department wrote that “even assuming, arguendo, that [the employee] was terminated without cause, we conclude that such termination would not render the restrictive covenants in the [agreement] unenforceable.” 115 A.D.3d 162 at 170. Justice Whalen went on to emphasize that the court in Post dealt only with a forfeiture-for-competition clause; i.e. he concluded that Post does not create a per se rule applicable to all restrictive covenants. Id at 170.

While there is admittedly confusion in this area of the law in New York, the most recent cases support the view that non-compete provisions are not per se unenforceable in New York solely because an employee has been terminated involuntarily without cause.

Central to a correct prediction of a court’s ruling regarding the enforceability of a non-compete provision is a determination of what exactly the covenant purports to restrict and what the penalties for noncompliance are to be. Based upon the New York case law that has developed since Post, there can be no doubt that a forfeiture-for-competition clause, which stipulates that an employee will lose certain entitlements, such as pension benefits, upon involuntary termination without cause will not be upheld. However, we cannot have the same certainty when the non-compete provision does not involve the forfeiture of pension or other benefits.

Because of the uncertainty in this area of the law, capable management side employment counsel should participate in drafting or revising all non-compete provisions so that they can be crafted in such a way as to make enforceability more likely. The lawyers at Richard Friedman PLLC regularly counsel corporate clients in connection with such provisions as well as other provisions that are part of employment agreements, severance agreements, and consulting agreements and litigate concerning those provisions when appropriate.

Richard B. Friedman
Richard Friedman PLLC
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Seeking to Enforce Vested Restricted Stock Units and Other Earned Compensation by Richard Friedman

Seeking to Enforce Vested Restricted Stock Awards and Other Earned Compensation

In New York, a promise of good faith and fair dealing is implicit in every contract. 511 W. 232nd CORP v. Jennifer Realty Co., 98 N.Y.2d 144, 153 (2002); Smith v. General Acc. Inc. Co., 91 N.Y.2d 648, 652-653 (1998); Dalton v. Educational Testing Serv., 87 N.Y.2d 384, 389 (1995) A contract is breached when a party acts in a manner that deprives the other party of the right to receive the benefits to which it is entitled under the agreement even if such action is not expressly forbidden by any contractual provision. The implied covenant protects the reasonable expectations of each party arising out of the written agreement it entered into. Jennifer Realty Co., 98 N.Y.2d 144, 153; accord M/A-COM Sec. Corp. v. Galesi, 904 F.2d 134, 136 (2d Cir. 1990). 

The purpose of an implied covenant of good faith and fair dealing is to further the parties’ agreement by protecting each party against a breach of the parties’ respective reasonable expectations derived from the agreement. It is intended to remedy the situation of one party’s attempts to undermine the contract by taking actions inconsistent with the contract that is not explicitly addressed in the language of the contract. (See Glen Banks, New York Contract Law (Vol. 28, New York Practice Series) (2005)) Thus, a breach of the covenant is a breach of the contract itself, the covenant being part and parcel of the contract. Boscorale Operating, LLC v. Nautica Apparel, Inc. 298 A.D.2d 330, 331 (1st Dept. 2002).

In the financial services industry, the implied covenant of good faith and fair dealing applies to vested restricted stock units (RSUs) awarded as part of many compensation packages (i) on the annual “Compensation Day” that numerous investment and commercial banks have and (ii) at other times. When an employee resigns from his employment, the employer’s forfeiture of an employee’s vested RSUs is a breach of contract if the employer acts in bad faith in order to deprive the employee of his vested options. Although companies have discretion in interpreting, applying, and performing the terms of the applicable stock options agreement, that discretion cannot be exercised arbitrarily. 

It is axiomatic under New York law that, where a contract contemplates the exercise of discretion, the implied covenant includes a promise not to act arbitrarily or irrationally in exercising that discretion. Sorensen v. Bridge Capital Corp., 52 A.D.3d 265, 267 (1st Dept 2008) New York courts have repeatedly recognized even an explicitly discretionary contract right may not be exercised in bad faith so as to frustrate the other party’s right to the benefit of the agreement. Hirsch v. Food Resources, Inc., 24 A.D.3d 293, 296 (1st Dept 2005); Richbell Information Services, Inc. v. Jupiter Partners, L.P., 309 A.D.2d 288, 302 (1st Dept 2003). 

For example, in Johns v. International Business Machines Corp. (“IBM”), 361 F. Supp. 2d 184 (S.D.N.Y. 2005), an employee claimed that the employer wrongfully classified his termination as one “for cause” so as to require his forfeiture of stock options. The court stated that, under New York law, “a corporation’s decision regarding a classification of departing employee affecting his benefits could be set aside by the court only if the appellant could sustain the heavy burden of establishing that the challenged benefit decision was the result of bad faith, fraud, or arbitrary action.” Id. at 189 The court went on to hold that there were disputed facts warranting a trial as to whether the decision to forfeit the vested options was made “honestly and in good faith.” Id. at 190. 

Therefore, if an employee can show that the forfeiture of his or her vested stock options was exercised in bad faith, he or she is entitled to an award of monetary damages to compensate for the injury he or she suffered as a result of the employer’s breach of contract. 

Besides a claim for breach of the implied covenant of good faith and fair dealing, a former employee whose vested RSUs or other earned compensation was terminated or rescinded can also bring certain alternative claims under principles of New York law. For instance, an employee can bring a claim for damages under unjust enrichment. The underlying principle of unjust enrichment is that the employer, although guilty of no underlying wrongdoing, has received money to which he or she is not entitled. To state a cause of action for unjust enrichment, an employee must allege that he or she conferred a benefit upon the employer and the employer obtained such benefit without adequately compensating the employee. The employee needs to establish the following three elements: 

  1. the employer received services provided by the employee;
  2. the employer benefited from the receipt of such services; and
  3. under principles of equity and good conscience, the employer should not be permitted to retain the value of such services without payment for services. 

At a minimum, under the doctrine of unjust enrichment, an employee should be paid the monetary damages equivalent of the value of the vested RSUs.  

If there are issues concerning the existence or enforceability of a contract, an employee can bring a claim under the doctrine of quantum meruit (meaning “as much as he deserved” in Latin). Here, the law typically implies a promise from the employer to the employee that the employee will be paid the reasonable value of the services he or she rendered or the benefit conferred upon the employer. In order to successfully state a claim under this doctrine, the individual who rendered services (the “Individual”) needs to establish four elements: 

  1. the Individual performed the services in good faith;
  2. the services were accepted by the person or organizations;
  3. the Individual expected to be compensated for his or her services; and
  4. the amount of damages that are recoverable, including the costs properly and reasonably incurred by the Individual and a reasonable allowance for profit. 

Therefore, when an Individual finds himself or herself in a situation where there may be no enforceable contract, there are some steps he or she can take in order to preserve a possible quantum meruit claim. Since the burden is on the Individual to demonstrate damages, i.e.,  the reasonable value of services he or she rendered, it is always a good idea for people to try to keep detailed records of the work performed and any costs incurred. Furthermore, the Individual should make clear his or her expectation to be paid for the work he or she performed and make a written demand for payment. If it appears that the organization is attempting to avoid its obligation to pay the Individual for the services he performed, he should immediately seek legal advice in how to properly preserve his quantum meruit claim so he can seek to receive the compensation he believes he deserves.

Richard B. Friedman
Richard Friedman PLLC
830 Third Avenue, 5th Floor
New York, New York 10022
TEL: 212-600-9539
FAX: 212-840-8560
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Data Privacy and Security: An Introduction for In-house and Outside Counsel by Richard Friedman

Data Privacy and Security: An Introduction for In-House and Outside Counsel

As is widely recognized, the attorney-client privilege is one of the most important fundamental principles in the legal profession. Every attorney has an obligation to protect his or her clients’ information and to keep attorney-client communications confidential. Of course, this principle applies to in-house counsel as well as outside counsel. Accordingly, it is crucial for both corporate legal departments and law firms to adopt and implement safeguards in order to protect client information. Although all lawyers presumably know that they have a duty to protect privileged client communications and information, many do not know how to do so. This article will briefly introduce the complex related topics of data privacy and security and provide some helpful initial steps that in-house and outside counsel should take in developing a plan to safeguard client information.

In this digital era, massive amounts of data are stored and transmitted electronically across a sea of systems and devices. In almost every kind of matter involving an organization, in-house and outside counsel have access to clients’ and employees’ personal information. It is no longer sufficient for in-house and outside counsel to rely solely on a company’s or a law firm’s IT department to handle cyber security issues. Indeed, many large companies, particularly in the financial services sector, are now conducting audits of their law firms’ data security protocols. A comprehensive data security plan needs to be developed in every organization and law firm by one or more lawyers in conjunction with the IT Department or an IT consultant and other stakeholders, if any, as described below.

1. Statutes and Regulations

The very first step that in-house and outside counsel should generally take on behalf of their client organization with regard to data privacy is to determine the governing state statutes and regulations regarding data privacy and security protection. Some states have data privacy laws that require companies to develop written policies and procedures to provide administrative, physical, and technological safeguards for sensitive client information. By way of example only, here are a few statutes and regulations that counsel charged with participating in the development of cyber security policies and practices should be mindful of: 

•Statutes that Protect Social Security Numbers: New York, New Jersey, Connecticut, and Michigan have statutes that require written policies to limit access to employees’ Social Security numbers. In Michigan and Connecticut, companies need to maintain and publish a specific corporate policy in order to require Social Security numbers from customers.

•Comprehensive Data Security Program RequirementsAn increasing number of states, such as California, Connecticut, Florida, Illinois, Indiana, Massachusetts, Maryland, Oregon, and Texas, require companies to take affirmative actions to protect personal information that belongs to the residents of those states, including driver’s license numbers, bank account numbers, Social Security numbers, and medical information.  

•Payment Card Industry Data Security Standards: Many corporations receive payments from clients and therefore have access to clients’ credit card information. These corporations need to make sure that they comply with the Payment Card Industry Data Security Standards.

•Breach Notification Requirements: All but three states require companies to provide notice when there has been a breach of “personal information” accessible to the organization.

2. Identify Personal Client Information

State statutes and regulations should be just the starting point in seeking to ensure data privacy protection. In-house and outside counsel should consider, for instance, the types of personal client information to which the organization in question has access; whether the organization maintains such personal information indefinitely; whether the organization sponsors or provides services to health care plans; and whether the organization has a comprehensive plan to respond to data privacy breaches.

3. Establish Internal Group to Coordinate Data Privacy Issues

Virtually every legal department should consider establishing an internal group to coordinate data privacy issues. This group should generally include personnel from the IT Department, the Accounting Department, the Human Resources Department, and the Legal Department—the areas where client personal information is often accessed the most. The group should be empowered to establish detailed steps to protect client data. For example, the group should consider:

Identifying all hardware, software, and devices such as laptops and cellphones that could store client information;

Classifying all digitally stored information by levels of sensitivity;

Determining which departments and which employees are most likely to have access to sensitive client information and how the information flows through the organization;

Identifying vendors and other third parties who maintain confidential client information; and

Reviewing existing agreements which require the organization to safeguard client information.

4. Protocol for Data Breach Response

Counsel should also develop a protocol for responding to data breaches, including, among other things, who will lead the response teams, and which templates to use for various types of data security-related communications.

5. Training

Law firms and legal departments should provide periodic training for employees who have access to client information and keep them informed about state regulations and charges in the company’s data privacy policies. In-house and outside counsel need to be thorough and thoughtful in helping their organizations identify, maintain, and safeguard all client information that their organizations maintain.

CONCLUSION

It is essential for in-house and outside counsel to take the foregoing steps in order to protect client information. Since individual and business clients increasingly demand heightened privacy protection, companies and law firms that fail to implement comprehensive data security policies will risk losing competitive advantage in the marketplace. In-house and outside counsel should share a leadership role with IT and other personnel in developing and implementing detailed internal policies and procedures for collecting, using, and disclosing the information that is needed to provide the services that their organizations render.  

Richard B. Friedman
Richard Friedman PLLC
830 Third Avenue, 5th Floor
New York, New York 10022
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Social Media Policies and the NLRB by Richard Friedman

Social Media Policies and the NLRB

The National Labor Relations Board (“NLRB”) has continued to shape social media policies and practices at work for both employers and employees through recent decisions. This article will briefly discuss several such decisions which shed light on National Labor Relations Act (“NLRA”)-protected union activities, the standards for employees’ disloyalty, and the standards for appropriate social media policies implemented by employers.

In Pier Sixty, LLC, Nos. 02-CA-068612 and 02-CA-070797, an employee of a catering company posted “obscene vulgarities” on his Facebook page regarding a manager’s mistreatment of certain employees two days before a union representation election and was fired soon thereafter. The Board adopted the decision of the administrative law judge who had applied the totality of circumstances test to evaluate the employee’s post. The judge considered the following factors:

1. whether the record contained any evidence of the Respondent’s anti-union hostility;

2. whether the Respondent provoked Perez’ conduct;

3. whether Perez’ conduct was impulsive or deliberate;

4. the location of Perez’ Facebook post;

5. the subject matter of the post;

6. the nature of the post;

7. whether the Respondent considered language similar to that used by Perez to be offensive;

8. whether the employer maintained a specific rule prohibiting the language at issue; and

9. whether the discipline imposed upon Perez was typical of that imposed for similar violations or disproportionate to his offense. 

In consideration of the above, the judge found that the employee’s conduct was not so egregious as to lose the protection under the Act and that the employer had violated the Act by discharging the employee for his protected, concerted comments made on social media two days before the election for union representation. This decision has been appealed to the Second Circuit. 

Similarly, in Novelis Corporation, No. 03-CA-121293, et al., the Board affirmed an administrative law judge’s finding that the employer was in violation of the NLRA by demoting an employee for his protected, concerted comments on Facebook. In this instance, the employee had merely expressed discontent regarding the conditions of his employment without disparaging the employer or demonstrating disloyalty. 

An evaluation of employees’ disloyalty occurred in a subsequent decision made in September 2016 in DirecTV, Inc. v. NLRB, No. 11-1273. After a group of technicians interviewed with a local television news station and complained about their company’s new pay policy scheme, they were fired for participating in the interview. The Board found that the interview was a protected activity under the NLRA, the employees’ statements being within the Act’s protection. The D.C. Circuit Court of Appeals affirmed the Board’s ruling, finding that the employees’ complaints were protected under the following NLRA two-prong test: 1) the complaints were related to an ongoing labor dispute; and 2) the employees’ actions were not disloyal or maliciously untrue. The Board concluded that the technicians had little, if any, control over the editing of the interview, their statements were not untrue, and the statements were not made “recklessly without regard for the financial consequences to” the company. 

The Board continues to push back on overly restrictive social media policies put in place by certain employers. In Chipotle Services LLC d/b/a Chipotle Mexican Grill, Nos. 04-CA-147314 and 04-CA-149551, an employee was asked to delete some tweets he had posted on his personal Twitter account through which he communicated with customers and discussed negative working conditions. The Board found that the employer had violated NLRA §8(a)(1) by maintaining a rule entitled “Social Media Code of Conduct” which prohibited employees from posting “incomplete, confidential, or inaccurate information” and making “disparaging, false, or misleading” statements. The Board noted that when rules are overly broad in scope or restrictive, they may interfere with employees’ lawful exercise of their rights under Section 7 of the NLRA, i.e., protected concerted activities. 

However, there are situations where employees will lose the protection of the Act when they post certain types of information on social media. For example, if an employee posts insubordination plans in great detail on social media, the employee will lose the protection of the Act. In Richmond District Neighborhood Center, Nos. 20-CA-091748, two employees, who led after school activities for students, exchanged information on Facebook regarding planned insubordination in specific detail, including what kind of people they would invite to their events and what type of things they would teach the kids the following year. The Board found that the employees’ Facebook postings described specific insubordinate acts that were objectively so egregious as to lose the Act’s protection and concluded that the Center’s rescission of the employees’ job offers for the following year was justified because they were unfit to work there. 

Richard B. Friedman
Richard Friedman PLLC
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New York, New York 10022
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Issues Arising in Negotiating Severance Agreements by Richard B. Friedman

Issues Arising in Negotiating Severance Agreements

At the risk of stating the very obvious, a severance agreement should contain releases which protect the former employer from potential lawsuits brought by the former employee and his or her heirs. Severance compensation can serve as an important transition financial resource for a former employee. Thus, it is often in both parties’ interests to reach an agreement. This article will briefly identify some of the provisions that should be considered for possible inclusion in a severance agreement. 

Provisions for Consideration in a Severance Agreement 

Of course, the agreement should set forth the amount of severance compensation to be paid to the former employee as well as the timing of such payments. Some companies have severance policies which tie severance payment amounts to the length of an employee’s service. Many companies leave such terms for negotiation on an individual basis after an employee’s employment is terminated.

Some of the other financial terms often addressed in severance agreements, which will vary depending on the seniority of the employee, are the following:

  • health insurance;
  • unused vacation time and/or sick leave pay;
  • earned and unpaid “bonus” payments; and
  • vested and non-vested stock options.  

Severance agreements of senior personnel often provide the former employee with a certain period of outplacement services to assist him or her in securing his or her next position. A severance agreement should provide that the company will respond to inquiries from prospective employers by solely providing the former employee’s dates of employment and the last position he or she held.  

In exchange for receiving various types of severance compensation, the former employee should always be required to release all claims, whether known or unknown, on behalf of himself or herself and all heirs against the former employer. The former employee should also be required to agree to a covenant not to sue the company or to become a member of any class seeking to sue the company or to provide any assistance to any persons suing the company.  

From the employee’s perspective, ideally the former employer should also agree to release the former employee from all known claims (at a minimum) up to the date of the release. However, companies should be very reluctant to release claims against former employees that are not already known to the company since doing so would relegate the company if it subsequently learned of such a claim to an allegation that, mindful of his improper conduct, the former employee fraudulently induced the company into signing the severance agreement. Of course, a dispute could eventually ensue as to whether a particular claim was known by the company at the time the agreement was executed. One way to try to avoid that dispute is for the former employee’s counsel to try to persuade the company’s counsel to have all possible claims known by the company identified in the severance agreement if the company is unwilling to waive all known and unknown claims.  

Employers should give serious consideration to including some or all of the following provisions in severance agreements: 

  • A new non-compete provision or the reaffirmation or expansion of an existing such provision.
  • A provision whereby the former employee agrees to make himself or herself reasonably available to, and cooperate with, company personnel with respect to claims threatened or brought against the company or its officers, directors, and employees.
  • A provision requiring the former employee to notify the company if he or she is contacted by someone who is or may be legally adverse to the company and if he or she receives a subpoena relating to the company.
  • A confidentiality provision.
  • A non-disparagement clause.
  • A provision whereby the former employee waives all rights to future employment with the company and any affiliates.
  • A provision whereby the former employee represents that he or she has returned all tangible property of the company regardless of whether it contains trade secrets or other proprietary information of the company.  

In my view, all severance agreements, indeed all agreements, should have choice of law and choice of venue provisions. A severance agreement should also provide that it is the entire agreement between the parties and supersedes any prior agreements between them.  

Potential Severance-Related Issues 

Employers should give serious consideration to establishing standard severance policies with specified severance compensation packages for employees at different levels of seniority within the organization.  

If an employee is asked to agree to what he or she considers to be overly restrictive non-compete provisions, he or she should seek additional monetary compensation. However, employers should defer payment of some severance compensation to try to ensure the former employee’s compliance with his or her obligations under the agreement.  

Importance of Severance Agreements to Employers 

If there is a possibility that an employee has one or more causes of action against his or her former employer for any reason, he or she may be able to build a strong case in reliance upon his or her in-depth knowledge of the company. Of course, this is one of the main reasons why an employer would want assurance that the employee cannot sue the employer. Avoiding potential lawsuits and the concomitant distraction to management and inevitable legal fees is generally of great benefit to a company and will often override the additional monetary and other compensation that former employees and their counsel will seek through negotiation. Severance agreements are also a useful way for an employer to bolster an existing non-compete provision when it is considered desirable to do so in view of changed circumstances.  

Of course, every situation is different. We regularly counsel mid-level and senior executives as well as companies in connection with their respective unique circumstances.

Richard B. Friedman
Richard Friedman PLLC
830 Third Avenue, 5th Floor
New York, New York 10022
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Defend Trade Secrets Act of 2016 by Richard Friedman

Defend Trade Secrets Act of 2016

In the Digital Information Age, where electronic data containing confidential information is so easily transferable, employers face a dilemma. On the one hand, they generally want to allow employees as much access to information as possible to promote efficient and uninterrupted workflow. On the other hand, there is always the risk that employees with access to highly sensitive information may misplace hard copies and/or flash drives containing such information or purposefully take key information to use on behalf of a competing future employer, for a business they have started or intend to start, or to damage the company because of a personal vendetta.  

Defend Trade Secrets Act of 2016 

To address this dilemma, the Defend Trade Secrets Act of 2016 (DTSA) was signed into law by President Obama on May 11, 2016, and became effective immediately. It provides for enhanced remedies for misappropriation of information deemed to be trade secrets and creates a number of new remedies for plaintiffs. The Act creates a federal civil cause of action for trade secret misappropriation for the first time and provides for the following remedies: injunctions; damages awards for economic loss arising from the misappropriation; and “in extraordinary circumstances” issuance of “an order providing for the seizure of property necessary to prevent the propagation or dissemination of the trade secret that is the subject of the action.” Further, if a court finds that the “trade secret is willfully and maliciously misappropriated,” it may “award exemplary damages” up to twice the amount of the damages awarded. 

Employers’ Responsibilities Under the Act 

In order to avail themselves of the Act’s remedies, trade secret owners must inform their employees that they will not be held liable for disclosures of information deemed to be trade secrets that “(A) [are] made (i) in confidence to a Federal, State, or local government official, either directly or indirectly, or to an attorney; and (ii) solely for the purpose of reporting or investigating a suspected violation of law; or (B) [are] made in a complaint or other document filed in a lawsuit or other proceeding, if such filing is made under seal.” Once employees are on such notice vis-a-vis a written policy in a company code of conduct or otherwise, employers may seek remedies under the DTSA. 

But the DTSA is not intended to blindly empower employers against employees. “If a claim…is made in bad faith, which may be established by circumstantial evidence,” or “a motion to terminate an injunction is made or opposed in bad faith,” a court can award reasonable attorney’s fees to the prevailing party. In addition, if the court finds that the seizure order was “wrongful or excessive,” the defendant “has a cause of action against the applicant for the order under which such seizure was made….” 

The foregoing measures were included to protect individuals against wrongful claims. Needless to say, trade secret owners and their counsel must carefully evaluate possible claims under the DTSA before commencing legal action.

Richard B. Friedman
Richard Friedman PLLC
830 Third Avenue, 5th Floor
New York, New York 10022
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