Category: Employment Law

a key pointing at an at sign with locks on it over a computer keyboard

Is the CFAA Violated when an Employee Accesses Authorized Information for an Improper Purpose?

 

Can an employee be found criminally or civilly liable under the Computer Fraud and Abuse Act (CFAA”) for accessing digital information to which she or he had authorization when done for an improper purpose? The answer prior to the June 2021 decision by the U.S. Supreme Court in Van Buren v. United States, 141 S. Ct. 1648 (2021), was unclear and varied between jurisdictions.

The Computer Fraud and Abuse Act:

Under the Computer Fraud and Abuse Act, civil and criminal liability may be pursued against any person who knowingly accesses a computer without authorization or “exceeds authorized access” to obtain and or misuse information from the computer.1 The Act defines “exceeds authorized access” as “access[ing] a computer with authorization to obtain or alter information in the computer that the accessor is not entitled so to obtain or alter…”2 The statute does not contain a definition of “with authorization” or “without authorization,” which contributed to inconsistent lower federal court decisions.

Van Buren’s Misuse:

Nathan Van Buren served as a sergeant in the Cumming, Georgia Police Department. His position afforded him authorized access to the Georgia Crime Information Center, which included the authority to scan license plates from his patrol car. Andrew Albo was known by the local police to patronize prostitutes and then accuse them of stealing money from him. Albo recorded a conversation in which Van Buren asked him for a $15,000 loan and provided the recording to the local sherrif’s office, alleging that Van Buren was “shaking him down.” After being contacted by the sheriff’s office, the FBI set up a sting operation in which Albo asked Van Burn to run the license plate of a stripper he was supposedly interested in soliciting for sexual services to see if she was an undercover police officer before he would provide Van Buren with the full amount of the loan. Van Buren complied with the request and was arrested. A jury convicted him under the CFAA and sentenced him to eighteen months in prison. Van Buren appealed to the Eleventh Circuit, arguing that the prosecution’s analysis of the CFAA, that an employee with authorized access to a database who used it for purposes inconsistent with the employer’s interest violated the CFAA, was flawed. In upholding the conviction, the Eleventh Circuit chose not to apply a narrower interpretation of “with authorization” that certain other circuit courts had used.

Supreme Court Decision:

In its Decision reversing the Eleventh Circuit, the Supreme Court held that the CFAA does not cover “those who… have improper motives for obtaining information that is otherwise available to them.”3 Specifically, Justice Amy Coney Barrett, writing for a majority of six, with Chief Justice Roberts and Justices Thomas and Alito in dissent, wrote that a person violates the “exceeds authorized access” language of the CFAA only when they access information that that is off-limits to them in a database or computer network to which they otherwise have access. Justice Barrett pointed out that Van Buren, on the other hand, obtained information to which he was entitled and held that the fact that he did so for an improper purpose did not violate the CFAA. A contrary holding that every violation of a computer-use policy violated the CFAA. Justice Barrett wrote, would lead to the conclusion that millions of otherwise law-abiding citizens could be subjected to criminal sanctions under the CFAA. Under the Court’s analysis, prosecutors and company plaintiffs would have to prove that an employee misused computers, servers, or software she or he did not have the authority to access, or whose access had expired, in order to convict or impose civil liability under the CFAA. Accessing data for a nefarious purpose, the Court held, is not alone sufficient to justify criminal or civil liability under the CFAA.

Justice Barrett wrote that Van Buren’s use of the license plate scanner in the manner he was permitted, “regardless of whether he [scanned] the information for a prohibited purpose,” did not violate the CFAA.4 The Government interpretation and Eleventh Circuit ruling would “attach criminal penalties to a breathtaking amount of commonplace computer activity…”5 adding “extra icing on a cake already frosted,” according to the majority.6

The decision in Van Buren means that the CFAA criminalizes computer hacking but does not extend to criminalize violations of “purpose-based limits contained in contracts and workplace policies.”7 A person with access to a set of files who uses them in a way prohibited by her or his employment contract would not violate the CFAA by doing so. An infraction would occur only if that person hacked into files he or she was unauthorized to use. Of course, such actions, though not criminal under the CFAA, would almost certainly violate company policies or breach an employment agreement.

Next Steps for Employers:

In view of Van Buren, employers concerned with protecting sensitive information on company servers should implement multiple measures to secure it such as:

  • Reassessing company security policies;
  • Investing in encryption software or renewing existing encryption services;
  • Requiring that existing employees and new hires sign confidentiality agreements; and
  • Limiting access to protected files to individuals responsible for their contents.

1 18 U.S.C § 1030(a)(2).
2 Id.
3 Van Buren v. United States, 141 S. Ct. 1648 at 1652.
4 Van Buren, 141 S. Ct. at 1654.
5 Id. at 1661.
6 Id. quoting Yates v. United States, 135 S. Ct. 1074 (2015)
7 Id. at 1662.


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
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Still image: Binder labeled "trade secrets" resting on top of business papers and graphs.

Defend Trade Secrets Act of 2016: A Five Year Overview

The Defend Trade Secrets Act of 2016 (“DTSA”) turned five years old on May 11, 2021. As a follow-up to our last article concerning misappropriation of trade secrets litigation, we are devoting this article to a review of the litigations which have arisen out of this relatively new statute.

The DTSA created a private federal cause of action for misappropriate of trade secrets for the first time. The law states, in part, that “[a]n owner of a trade secret that is misappropriated may bring a civil action under this subsection if the trade secret is related to a product or service used in, or intended for use in, interstate or foreign commerce.”1 Employers should consider invoking the statute in order to seek to prevent further disclosure of information they consider to be trade secrets if they: (i) believe such information may have already been exposed; (ii) seek to enjoin any further dissemination; (iii) seek to recover the alleged trade secrets; and/or (iv) seek to obtain monetary damages for losses related to the misappropriation, if any.

But there are quite a few defenses that defendants can assert to such an action, as was the case with the former senior partner of a preeminent consulting firm which our firm recently represented in an action in the District of New Jersey which was dismissed with prejudice in connection with settlements between the consulting firm and: (i) our client’s subsequent employer; and (ii) our client. Although our firm’s matters in recent years in this arena have been on behalf of defendants and prospective defendants, this article will hopefully provide some helpful suggestions for both plaintiffs and defendants under the DTSA.

Defining a Trade Secret

A company suing under the DTSA must prove that what has been misappropriated is in fact a trade secret. To succeed under the DTSA, a plaintiff must demonstrate both that it took reasonable measures to keep the information actually secret, and that the secret in question has economic value independent of not being generally known or available to ascertain by the public. Courts will generally then make a fact specific determination regarding whether the steps taken to keep the information secret were in fact “reasonable.” A useful illustration is WeRide Corporation, et al. v. Kun Huang, where the court held that restricting access with a password, encrypting the source code at issue, and requiring employees to sign guidelines that mandated protection of the company’s confidential information was enough to prove that reasonable measures had been taken with respect to the trade secrets.2 On the other hand, in Temuran v. Piccolo,3 the court held that sufficient steps had not been taken to protect the information at issue as the plaintiff had not alleged having employees sign any type of confidentiality agreement. A plaintiff must also allege more than an intent to keep information secret.4

Proving that a trade secret has independent economic value to the plaintiff is vital to a successful DTSA claim. In some instances a company can provide a court with a specific monetary value that was used to develop or create the trade secret. In WeRide, for example, the company alleged it spent over $45 million in developing the source code that was the trade secret at issue.5 Where monetary amounts can be proven with specificity, claiming that the trade secrets permit a company to maintain a competitive advantage can be enough to satisfy the independent economic value requirement in certain circumstances.6 However, if there is a means of recreating the information or a way to publicly access the information, the DTSA claim will fail on the grounds that the information has no special value to the company.

Using the Trade Secret in Interstate Commerce

The clause requiring the secret to be “related to a product or service used in, or intended for use in, interstate or foreign commerce”7 is understood broadly to mean that there must be some nexus with interstate commerce. Some examples that count for this requirement are: use of a former employer’s customer list to solicit out-of-state customers,8 sharing an employer’s trade secrets with customers around the world,9 soliciting business for a new employer from a former employer’s multi-state client contact list,10 shipping products to California customers from a Nevada warehouse,11 and using a former employer’s patient lists to solicit patients in a different state.12

Timing of Misappropriating the Trade Secret

Since the DTSA was only signed in 2016, some temporal issues arise in bringing a claim thereunder. The claim must be plead from the date of the initial misappropriation rather than the date when the plaintiff became aware of the misappropriation. However, some courts have sustained DTSA claims in response to motions to dismiss even if the misappropriation started before the law was enacted so long as it continued after the statute became law.13 At least one court has even allowed a claim to continue where there was pre-enactment taking of an alleged trade secret and post-enactment disclosure.14 Thus, while the law is technically forward looking from the time of enactment, courts have allowed claims to move forward in certain circumstances where the conduct straddled the effective date of the law.

Remedies

If a plaintiff is successful in proving its case, it may be entitled to remedies at law and in equity. The law provides for ex parte seizures of the trade secrets. Compensatory damages can be measured by: (i) unjust enrichment to the extent not accounted for in the actual loss calculation; or (ii) a reasonable royalty for the unauthorized disclosure or use of the trade secret. Punitive damages are also available up to two times the amount of the damages for willful and malicious misappropriation. An ex parte seizure order can enable a plaintiff to seize electronic software or hardware, papers, and other information belonging to the defendant(s) that contain the plaintiff’s trade secrets.

The DTSA is a great tool in the toolbox of employers who believe their trade secrets have been misappropriated. However, ample defenses are available to a defendant which require a plaintiff to prove that the information allegedly misappropriated is entitled to legal protection.


1 18 U.S.C.A. § 1836 (b) (1)
2 WeRide Corp. v. Kun Huang, 379 F. Supp. 3d 834 (N.D. Cal. 2019)
3 Temurian v. Piccolo, No. 18-CV-62737, 2019 WL 1763022 (S.D. Fla. Apr. 22, 2019). The Court also noted:  “Generally, limiting employee access to the information and password-protecting the computer network on which the information resided [a]re positive steps in securing the alleged trade secret.”  Yellowfin Yachts, Inc., 898 F.3d at 1300.  However, those efforts may be undermined by the subsequent failure to safeguard the use of and access to the alleged trade secret.  Id. at 1301.  Indeed, “[d]isclosing the information to others who are under no obligation to protect the confidentiality of the information defeats any claim that the information is a trade secret.”  M.C. Dean, Inc. v. City of Miami Beach, Fla., 199 F. Supp. 3d 1349, 1353 (S.D. Fla. 2016)”
4 Dichard v. Morgan, 2017 WL 5634110, at *2-3 (D.N.H. Nov. 22, 2017)
5 WeRide Corp. v. Kun Huang, 379 F. Supp. 3d 834 (N.D. Cal. 2019)
6 See, e.g., Teva Pharm. USA, Inc. v. Sandhu, 291 F. Supp. 3d 659, 675 (E.D. Pa. 2018)
7 18 U.S.C.A. § 1836 (b) (1)
8 Complete Logistical Servs., LLC v. Rulh, 350 F. Supp. 3d 512, 520 (E.D. La. 2018)
9 Source Prod. & Equip. Co., Inc. v. Schehr, 2017 WL 3721543, at *3 (E.D. La. Aug. 29, 2017)
10 Wells Lamont Indus. Grp. LLC v. Mendoza, 2017 WL 3235682, at *3 (N.D. Ill. July 31, 2017)
11 Officia Imaging, Inc. v. Langridge, No. SACV172228DOCDFMX, 2018 WL 6137183 (C.D. Cal. Aug. 7, 2018)
12 Yager v. Vignieri, 2017 WL 4574487, at *2 (S.D.N.Y. Oct. 12, 2017)
13 See, e.g., Hermann Int’l Inc. v. Hermann Int’l Europe, 2021 WL 861712, at *15-16 (W.D.N.C. Mar. 8. 2021)
14 Agilysis, Inc. v. Hall, 258 F. Supp. 3d 1331, 1348-49 (N.D. Ga. 2017)


Richard B. Friedman
Richard Friedman PLLC

200 Park Avenue Suite 1700
New York, NY 10166
TEL: 212-600-9539
rfriedman@richardfriedmanlaw.com
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Woman stabs a clueless coprorate executive in the back

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

The faithless servant rule is grounded in the law of agency and provides a tool that employers can use to try 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.1 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.”2

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.”3 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 so substantially violated his employment duties 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.

Although critics of the faithless servant doctrine have characterized it as overly punitive, the First Department obviously feels differently. In Mahn v. Mayor, Lindsey & Africa, LLC,4 it upheld an 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 arbitrator had found 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. The Court specifically held that the 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. 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,5 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. As in Beach, the plaintiff in Major Lindsey 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.

In Salus Capital Partners, LLC v. Moser6, a limited liability company (LLC) petitioned to confirm an arbitration award against its former Chief Executive Officer (CEO). The LLC’s claim arose out of the CEO’s use of corporate funds for personal purposes. The CEO moved for partial vacatur of the award.  The CEO contended that the damages award requiring him to disgorge several months of compensation should be vacated as an improper application of the faithless service doctrine. The CEO argued that the total award of $2.6 million was disproportionate to the amount in controversy since the CEO only misused $200,000 of corporate funds. The court disagreed with the CEO’s position, and upheld the arbitration award. 

The affirmation of the Major Lindsey arbitration award by the First Department and the Southern District of New York’s decision in Salus are obvious wins for employers and should serve as a reminder that the powerful faithless servant doctrine is alive and well in New York. They should also serve as warnings to potentially disloyal employees: the penalty for future misconduct may be much more than they “bargained for.”

However, there are instances when the employer will not fully recover under the faithless servant doctrine. The Second Circuit has carved out a limited exception where compensation is expressly allocated among discrete tasks, such as commissions. In such cases, the employee may keep compensation derived from any transactions that were separate from and untainted by the disloyalty. Specifically, apportionment is available when: 

(1) the parties agreed that the agent will be paid on a task-by-task basis (e.g., a commission on each sale arranged by the agent); (2) the agent engaged in no misconduct at all with respect to certain tasks; and (3) the agent’s disloyalty with respect to other tasks “neither tainted nor interfered with the completion of” the tasks as to which the agent was loyal.7

Of course, there are instances when employers have been unsuccessful involving the faithless servant doctrine in New York courts. For example, employers have been unsuccessful when they were not able to provide enough evidence of when and how the former employee acted as a faithless servant. For example, in the 2020 case, Babbitt v. Koeppel Nissan, Inc., the plaintiff worked for the defendant as a finance manager. The Defendants’ cross-claim that the plaintiff was a faithless servant failed because the defendants failed to provide any detail beyond conclusory allegations such as “The Plaintiff’s disloyalty permeated her services in its most material and substantial part.”8

Additionally, in Stefanovic v. Old Heidelberg Corp.,9 the defendants alleged in a cross-claim that the Plaintiffs, former restaurant personnel, had forfeited compensation paid to them during the periods of employment in which they altered the tips on customers’ receipts. The defendants alleged that plaintiffs were employed by the restaurant and harmed its interests by changing the gratuity amount on customer receipts to give themselves a higher tip.  As a result of the plaintiffs’ actions, the defendant stated a claim under the faithless servant. However, the defendants did not provide any specific instances of receipt altering by the plaintiff. Therefore, the defendants’ counterclaim was dismissed.

The court found in Leary v. Al-Mubaraki10 that the defendant’s counterclaims fail to state a claim under the “faithless servant doctrine.” The defendant did not prevail because he could not specifically allege how the plaintiff’s alleged disloyalty substantially affected his job performance. The defendant alleged only that between 2014 and 2017 the plaintiff’s work performance suffered significantly, leading to underperformance by his clients’ securities portfolios and causing his division to not be profitable. However, the defendant omits any facts concerning how its clients’ portfolios underperformed. The Court stated it could just as easily infer that any such portfolio underperformance or lack of profitability was caused by external market forces. 

Even though the faithless servant doctrine is alive and well in New York, employers need to recognize that, unless they can prove to the court that an employee acted as a faithless servant and the employee’s actions impacted the employer’s business, the employer will not prevail as mere allegations will not suffice in New York courts. 

________________________________________________________

1 Murray v. Bear. 102 N.Y. 505 (1886).
2 Id. at 508.
3 Feiger v. Iral Jewelry, Ltd., 41 N.Y.2d 928, 928-929 (1977).
4 159 A.D.3d 546 (App. Div. 2018).
5 Beach v. Touradji Capital Management, LP, 144 A.D.3d 557 (1st Dep’t 2016).
6 Salus Capital Partners, LLC v. Moser, 289 F. Supp. 3d 468 (S.D.N.Y. 2018).
7 Morgan.
8 Babbitt v. Koeppel Nissan, Inc., 2020 WL 3183895, (E.D.N.Y. June 15, 2020).
9 Stefanovic v. Old Heidelberg Corp., 2019 WL 3745657, at 4 (S.D.N.Y. Aug. 8, 2019).
10 Leary v. Al-Mubaraki, 2019 WL 4805849, at (S.D.N.Y. Sept. 30, 2019).


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
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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 a release which protects the former employer from potential lawsuits and other legal proceedings that could otherwise be 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 by every employer and employee.

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 executive with a certain period of outplacement services to assist him or her in securing his or her next position. Severance agreements frequently 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.

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.

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.

Ideally from the employee’s perspective, 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 are often 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 factual dispute could eventually ensue in a litigation as to whether a particular claim was known by the company at the time the agreement was executed.

This commentator believes that counsel for a former employee should generally seek to have the non-disparagement provision in virtually all severance agreements be mutual. In those instances where company counsel refuses to do so, the following approach can be considered. The agreement could contain a provision requiring that (i) several identified employees be notified in writing within a few business days after the execution of the agreement or the lapse of the revocation period not to disparage the former employee verbally or in writing and (ii) the former employee’s counsel be notified in writing within one or two business days thereafter that such notification was sent. However, this commentator has represented former executives who did not want any such persons to be so notified in the belief that doing so would “fan the flames” and have the opposite effect of what was intended.

We have been involved in several recent matters where, at the request of the former senior executive who we represented, several “C” suite executives were identified in the severance agreement with their consent as the only personnel authorized to provide reference information about the former executive beyond her or his dates of employment and last position. In two recent matters, we negotiated to have a reference letter signed by the CEO attached as an exhibit to the severance agreement with a provision that the company must make it available exclusively in response to any inquiries about the former executive.

Employers often include 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 (i) is contacted by someone who is or may be legally adverse to the company or (ii) 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 this commentator’s 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

Benefits of Employer Severance Policies

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. Several New York cases have considered the legal ramifications of company severance policies.

In Cohen v. Nat’l Grid USA,1 the plaintiffs, management employees, brought a breach of contract action against their former employer in which they alleged that they were entitled to severance pay under their former employer’s written “change of control” policy as a result of the merger of the former employer’s parent corporation and the subsequent sale of the former employer. The court held that the severance pay provision in the former employer’s policy manual, which provided severance pay to management employees if they were terminated without cause in the event of the employer’s merger with another corporation, was not an enforceable obligation.

In Hosain-Bhuiyan v. Barr Labs., Inc.,2 a former employee sued for breach of contract and violations of the New York Labor Law alleging that he was improperly terminated for cause and was contractually entitled to certain severance payments and stock options. The defendant’s employment policy provided that employees terminated for cause were not entitled to any severance compensation. The plaintiff had been terminated after it was determined that he (i) failed to disclose to the defendant in writing his ownership interest in another business and (ii) did work for his outside business during regular business hours. After concluding that the plaintiff had been properly terminated for cause, the Court granted summary judgement in favor of the former employer.

In Norris v. Soc. Servs. Employee Union 371,3 two individuals sued their former employer, a local union, for unpaid severance under an unwritten severance policy. The employees established their entitlement to three weeks of severance pay under the policy instead of the two weeks of pay offered by the defendant. The defendant failed to have a written severance policy as required by the Labor Law and governing regulations during the period of the former employees’ employment. Due to the defendant’s lack of compliance, the defendant was forced to pay the additional week of severance pay. Although the monetary amounts at issue in this matter were modest, the case underscores the importance of employers having a written severance policy.

Confidentiality

Certain issues that may arise with confidentiality provisions are demonstrated in John Mezzalingua Assocs., LLC v. Braunschweig.4 While employed by the plaintiff, the defendant was privy to trade secrets and confidential information essential to the success of the plaintiff’s business. As a result of defendant’s position, the information she possessed posed a threat to plaintiff’s economic viability and success if the information was disclosed to third parties. The plaintiff sent the defendant a written notice letter, stating that the defendant had breached her obligations to the plaintiff as set forth in her severance agreement. The plaintiff demanded repayment of all severance payments that the defendant had received under the severance agreement. In response, the defendant argued that the non-interference clause was limited to a six-month period following the execution of the severance agreement. The former employer claimed there was no time restriction on the former employee’s obligation not to affect or disrupt its pending or future sales. The former employee’s motion for summary judgement of the plaintiff’s breach of contract claim was denied.

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 a former employer would want an assurance that the former 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 a former employer to bolster an existing non-compete provision when it is considered desirable to do so in view of changed circumstances.

Importance of Severance Agreements to Former Employees

In addition to receiving severance compensation, which sometimes also includes the acceleration of certain stock options and company payment of COBRA insurance premiums for an agreed upon period of time, former employees can benefit from entering into a severance agreement by receiving, among other things, (i) a general release from their former employer or some variation thereof, (ii) a mutual non-disparagement provision or some variation thereof, (iii) agreed upon reference protocols which may include a reference letter to be used exclusively, and (iv) a limit on the former employee’s obligations to cooperate with her or his former employer in connection with future legal proceedings brought against the company.

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

200 Park Avenue Suite 1700
New York, NY 10166
TEL: 212-600-9539
rfriedman@richardfriedmanlaw.com
www.richardfriedmanlaw.com
www.richardfriedmanlaw.com/blog
Connect with me on Linkedin


1 Cohen v. Nat’l Grid USA, 36 N.Y.S.3d 686 (2016).
2 Hosain-Bhuiyan v. Barr Labs., Inc. Hosain-Bhuiyan v. Barr Labs., Inc., 2019 WL 3740614, at 1 (S.D.N.Y. Aug. 8, 2019), appeal dismissed, 2019 WL 8165864 (2d Cir. Dec. 27, 2019).
3 Norris v. Soc. Servs. Employee Union 371, 963 N.Y.S.2d 562 (Civ. Ct. 2013).
4 John Mezzalingua Assocs., LLC v. Braunschweig, No. 519CV00368BKSTWD, 2020 WL 210299, at *1 (N.D.N.Y. Jan. 14, 2020).

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

Current State of Restrictive Covenants (other than Non-Competes) Under New York Law

What is a Restrictive Covenant?

Our last blog article provided an update on the state of New York law concerning non-compete provisions. This article focuses on the state of New York law concerning restrictive covenant provisions other than non-competes. As our readers are almost certainly all well aware, a restrictive covenant is a contractual provision that many employers include in employment and severance agreements as well as in contracts with respect to the sale of a business. Such provisions 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, severance, and agreements concerning the sale of a business, these covenants can often be found in stock option agreements.

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  The test New York courts use to determine whether a restrictive covenant is reasonable was relied on recently by the United States District Court for the Eastern District of New York in Intertek Testing Servs., N.A., Inc. v. Pennisi.2 The court stated: “[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.” Applying this test, New York courts analyzing a restrictive covenant take a two-step approach:3

  1. The court first considers whether the covenant is reasonable in scope and duration; and
  2. If the answer to the foregoing is yes, courts consider 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 a restriction to be unreasonable when it covers a geographic area where the employer does not compete, or where the provision would effectively prevent the employee from continuing to work in a particular industry.4 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 former employer’s trade secrets, confidential customer lists, or protection from competition by a former employee whose services are unique or extraordinary.5 Additionally, such courts have found that an employer has a legitimate interest in protecting client relationships or goodwill developed by an employee at the employer’s expense.6

Types of Restrictive Covenants

Although non-compete provisions are the most common type of restrictive covenants, New York courts recognize the following other types of restrictive covenants:

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

1.  Non-solicitation Provisions

A non-solicitation provision is a restrictive covenant that prohibits former employees or the former owner of a business, for a specific period of time after the employment relationship ceased or the sale occurred, from soliciting the former employer’s or previously owned company’s customers or providing competing services to those customers.7 They often also prohibit the former employee or owner from trying, directly or indirectly, to secure business from the former employer’s or previously owned company’s customers.8

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 or owner from soliciting and/or performing services for certain categories of customers or specifically identified customers for a designated time period.9 King v. Marsh & McLennan Agency LLC10 is an example of a recent case in which a New York court enforced a non-solicitation provision for customers. In King, the Court held that the employer had an undeniable interest in enforcing a non-solicitation agreement to protect its customer relationships.

Non-solicitation provisions eliminate the need for the court to evaluate the reasonableness of a geographic restriction.11 Additionally, the absence of a non-compete provision also increases the likelihood that the court will find the non-solicitation clause in an employment agreement enforceable.12

Yet New York courts have found that a non-solicitation provision is too broad to be enforced as written if it is not necessary to protect 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.13

Establishing that an employee is unique can be very difficult as demonstrated in a case before the New York Appellate Division First Department last year. In that case, Harris v. Patients Med., P.C.,14 a medical practice appealed a ruling that denied its motion for a preliminary injunction enjoining a former employee, a doctor, from breaching restrictive covenants in her employment agreement. The Appellate Division determined that the employer did not have a substantial likelihood of success on the merits of its claim. Specifically, the Court held the former employer had not shown that the restrictive covenants were necessary to protect its legitimate interests as it failed to establish that the doctor’s services were unique or extraordinary such that they gave the employee an unfair advantage over the employer.15 Similarly, in Vertical Sys. Analysis, Inc. v. Balzano,16 the First Department reasoned that the employee, an elevator inspector, did not provide unique or extraordinary services or have any access to trade secrets or propriety information that would require the enforcement of a non-solicitation provision.

2.  No-hire Provisions

A non-solicitation clause that applies to the solicitation of employees of a former employer or a previously owned company has been referred to by many courts as a non-recruitment or a no-hire provision. Improper conduct in this regard includes identifying employees to be recruited, direct or indirect solicitation of employees, and speaking to employees concerning how they would like to be compensated by the new employer.17

This commentator is not aware of a New York Court of Appeals case adjudicating whether a covenant not to solicit employees is enforceable.  However, both the Appellate Division Second Department and New York federal courts have stated that New York recognizes the enforceability of covenants not to solicit employees.18 Like other restrictive covenants, they are subject to a reasonableness analysis but are considered inherently more reasonable than a covenant not to compete.  The United States District Court for the Southern District of New York has gone as far as to say that these types of provisions can be viewed as prima facie enforceable when they are reasonable in scope and limited in duration.19

A relatively recent case in the Southern District of New York demonstrates how courts are willing to enforce no-hire provisions. In Oliver Wyman, Inc. v. Eielson,20  an employer brought an action against two former employees, alleging fraud and breach of contract in connection with the acquisition by the plaintiff of the former employees’ consulting business. The Court held that the non-recruitment clause in the employees’ employment contracts was no more restrictive than necessary to protect the former employer’s legitimate interest in protecting its client base.21 The Court reasoned that the no-hire clause was acceptable because of its narrow scope because it only prevented the poaching of former co-workers for actual, available employment opportunities in which the solicitor of those workers has an interest.22 Additionally, the Court held that the non-recruitment clause in the former employees’ employment contracts did not impose an undue hardship on the former employees.23

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.24  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 and direct her or him not to come to work or perform services, giving the employees leave to “tend to their gardens” or pursue any other activity excluding other employment provided that the employee does not compete with her or his former employer.25 Extended notice provisions may be mutual but can also require that only the employee provide notice, with no similar obligation on the employer.26 Where mutual, these provisions without exception (to our knowledge) do not require such notice from employers where the employee is being terminated for cause.27

 


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 Flatiron Health, Inc. v. Carson, 2020 WL 1320867, at 19 (S.D.N.Y. Mar. 20, 2020).
2 Intertek Testing Servs., N.A., Inc. v. Pennisi, 2020 WL 1129773, at 19 (E.D.N.Y. Mar. 9, 2020).
3 Id; See also King v. Marsh & McLennan Agency, LLC, 67 Misc. 3d 1203(A) (N.Y. Sup. Ct. 2020). KCG Holdings, Inc. v. Khandekar, 2020 WL 1189302, at 17 (S.D.N.Y. Mar. 12, 2020).
4 Good Energy, L.P. v. Kosachuk, 49 A.D.3d 331 (1st Dep’t 2008).
5 Intertek Testing Servs., N.A., Inc. v. Pennisi, 2020 WL 1129773, at 21.
6 Id.
7 4B N.Y.Prac., Com. Litig. In New York State Courts § 80:8 (4th ed.).
8 Id.
9 Contempo Communications, Inc. v. MJM Creative Services, Inc., 182 A.D.2d 351 (1st Dep’t 1992). Genesee Val. Trust Co. v. Waterford Group, LLC, 130 A.D.3d 1555, 1558 (2015).
10 King v. Marsh & McLennan Agency, LLC, 67 Misc. 3d 1203(A) (N.Y. Sup. Ct. 2020).
11 Id.
12 Id.
13 Flatiron Health, Inc. v. Carson, 2020 WL 1320867, at 21 (S.D.N.Y. Mar. 20, 2020).
14 Harris v. Patients Med., P.C., 93 N.Y.S.3d 299 (N.Y. App. Div. 2019).
15 Id.
16 Vertical Sys. Analysis, Inc. v. Balzano, 621, 97 N.Y.S.3d 467 (N.Y. App. Div. 2019).
17 Marsh USA Inc. v. Karasaki, 2008 Wl 4778239 (S.D.N.Y. 2008).
18 See Intertek Testing Servs., N.A., Inc. v. Pennisi, 2020 WL 1129773, at 23 (E.D.N.Y. Mar. 9, 2020); General Patent Corp. v. Wi-Lan Inc., 2011 WL 5845194 (S.D.N.Y. 2011).
19 General Patent Corp. v. Wi-Lan Inc., Isd.
20 Oliver Wyman, Inc. v. Eielson, 282 F. Supp. 3d 684, 695 (S.D.N.Y. 2017).
21 Id.
22 Id.
23 Id.
24 4B N.Y.Prac., Com. Litig. In New York State Courts § 80:10 (4th ed.).
25 Id.
26 Id.
27 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. The purpose of a non-compete provision is to restrict a former employee’s ability to work for a competitor after the cessation of his or her employment.

When are Non-Competes Enforceable?

New York courts tend to disfavor non-compete provisions.1 However, as is also well known, non-compete provisions have been enforced where they have found to:

  1. Impose no greater restrictions than required to protect an employer’s legitimate protectable interests;
  2. Not impose undue hardship on the employee or be harmful to the general public; and
  3. Be reasonably limited temporally and geographically.2

Employer’s Legitimate Protectable Interests

In New York, employer’s legitimate protectable interests include:3

  1. Protection of trade secrets;
  2. Protection of customer relationships;
  3. Confidential customer; and
  4. “Unique” services.

The latter category has rarely been invoked by employers since it is very difficult to prove that an employee rendered unique services that cannot easily be replaced.

Scope of Restrictions

If a New York 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 to determine if a geographic restriction in a non-compete provision is reasonable. New York courts may be willing to enforce a broad geographic restriction so long as the duration of the restrictions is short. For example, in Interga Optics, Inc v. Nash, a Northern District of New York Judge, applying New York law, stated that “[e]ven if the geographic scope were found to be somewhat broad (due to the evidence that the vast majority of Plaintiff’s current clients appear to be limited to North and South America), the restriction is tempered by the brief duration of it.”4 In a February 2020 decision in Markets Grp., Inc. v. Oliveira, a Southern District of New York Judge, also applying New York law, held a non-compete provision unenforceable because it did not contain a geographical limit.”5
  2. Duration of the restriction. When reviewing the temporal period 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 also found certain longer non-compete provisions reasonable in light of other circumstances. For instance, an Eastern District of New York Judge held in March 2020 that a five year non-compete clause was reasonable in the context of the sale of a business.6
  3. The scope of the business activity impacted. New York courts will not enforce a non-compete provision 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 other confidential information such as customer lists. For example, the New York Appellate Division Fourth Department held that a non-compete provision precluding a former employee of a staffing agency (a physician assistant) from providing medical services to any hospital at which he had provided services through his prior employer was overly broad and therefore not enforceable.7

Other Factors and Situations Considered by NY Courts

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 (i) protect the new owner from having its business usurped by the former owner, and (ii) enable the former owner to extract a higher price in the sale to reward him or her for the goodwill which he or she may have spent years creating.8

Terminated Without Cause. An issue arises when an employee with a non-compete is terminated without cause. 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.9 However, the New York Court of Appeals has not issued a per se rule applicable to non-compete provisions in such circumstances. Indeed, in Morris v. Schroder Capital Management International,10 the Court of Appeals stated that “a court must determine whether forfeiture is ‘reasonable’ if the employee was terminated involuntarily without cause.”

In two very recent cases, judges in the United States District Court for the Southern District of New York considered whether non-compete provisions should be enforced where an employee was terminated without cause. In both cases the judges enforced restrictive covenants because they were not persuaded that the former employees had actually been terminated without cause.

In Beirne Wealth Consulting Servs., LLC v. Englebert,11 the relationship between the employees and employer had deteriorated beyond repair. After they were terminated, the defendants argued that the restrictive covenants in their employment agreements were not binding because they were terminated without cause. However, the Court disagreed that the former employees had been terminated without cause and enforced the non-compete provisions.

In a similar case, Kelley-Hilton v. Sterling Infosystems Inc,12 the plaintiff, a former employee, claimed she was wrongfully terminated by the defendant. The plaintiff moved for a preliminary injunction preventing her former employer from enforcing any contractual provisions that would prohibit her from competing with it, soliciting its customers, or hiring its employees. The plaintiff’s motion for a preliminary injunction was denied because the plaintiff failed to show she would be likely to prove she was terminated without cause.

Future of Non-Competes

A proposed New York statute would invalidate no-poach provisions which are sometimes found in contracts between employers. The bill would “prohibit agreements between employers that directly restrict the current or future employment of any employee and allows for a cause of action against employers who engage in such agreements.”13 The purpose of a no-poach provision is to restrict employers from soliciting or hiring another employer’s employees or former employees. But the proposed legislation would outlaw only no-poach agreements between employers and not apply to non-compete provisions in contracts between employers and current or former employees.14

In 2017, the New York Attorney General’s Office proposed BILL A07864A in the New York State Assembly which would substantially limit the enforceability of non-compete provisions. However, the failure of the legislature to adopt that or any similar proposal leads this commentator to believe that such legislation is unlikely to become law in New York in the foreseeable future.

Nonetheless, in view of the historically high unemployment rates caused by the COVID-19 pandemic and the attendant economic hardships being experienced by millions of New Yorkers, this commentator also believes that many New York courts are likely to become much less willing to enforce non-compete provisions other than (i) where the former employee is being paid during the period covered by the non-compete and (ii) in connection with the sale of a business.


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
Connect with me on Linkedin

____________________

1 Long Island Minimally Invasive Surgery, P.C. v. St. John’s Episcopal Hosp., 83 N.Y.S.3d 514, 516 (N.Y. App. Div. 2018) (medical practice brought action against surgeon and his subsequent employer, seeking damages and injunctive relief for an alleged breach of a restrictive covenant in the employment contract). 

2 Harris v. Patients Med. P.C., 93 N.Y.S.3d 299, 301 (N.Y. App. Div. 2019)(medical group appealed the denial of a motion for preliminary injunction enjoining former employee, a doctor, from breaching restrictive covenants in her employment agreement; the court ruled plaintiff did not have substantial likelihood of success on merits of its claim); see also Intertek Testing Servs., N.A., Inc. v. Pennisi, 2020 WL 1129773 (E.D.N.Y. Mar. 9, 2020).

3 Cortland Line Holdings LLC v. Lieverst, 2018 WL 8278554, at 6 (N.D.N.Y. Apr. 6, 2018). Intertek Testing Servs., N.A., Inc. v. Pennisi, 2020 WL 1129773 (E.D.N.Y. Mar. 9, 2020).

4 Integra Optics, Inc. v. Nash, 2018 WL 2244460, at 7 (N.D.N.Y. Apr. 10, 2018) (court enforced an employer’s preliminary injunction against a former employer as the non-compete agreement was deemed reasonable; specifically, the restriction on geographic scope was considered necessary to protect the employer’s government interest).

5 Markets Grp., Inc. v. Oliveira, 2020 WL 815732 (S.D.N.Y. Feb. 19, 2020) (court affirmed a summary judgement motion in favor of the defendant, a former employee, because the court found the defendant did not violate the non-compete provision of his employment agreement).

6 Intertek Testing Servs., N.A., Inc. v. Pennisi, 2020 WL 1129773, at 19 (E.D.N.Y. Mar. 9, 2020) (building and construction service provider brought action against employee of entity acquired by provider, former employees of provider, and competitor seeking injunctive relief non-compete provision of the contract, the provider was successful).

7 Delphi Hospitalist Servs., LLC v. Patrick, 80 N.Y.S.3d 616, 617–18 (N.Y. App. Div. 2018) (medical staffing agency brought action against physician assistant, seeking to enforce restrictive covenant in assistant’s employment agreement after assistant terminated his contract with agency; the defendant prevailed).

8 UAH-Mayfair Mgmt. Grp. LLC v. Clark, 110 N.Y.S.3d 849, 850 (N.Y. App. Div. 2019)(court granted former employer a preliminary injunction enforcing the non-compete provision of the employment agreement and awarded the plaintiff costs); see also 4D N.Y.Prac., Com. Litig. in New York State Courts § 105:21 (4th ed.).

9 See, e.g., Kelly-Hilton v. Sterling Infosystems Inc., 426 F. Supp. 3d 49 (S.D.N.Y. 2019); Beirne Wealth Consulting Servs., LLC v. Englebert, 2020 WL 506639, at 1 (S.D.N.Y. Jan. 30, 2020).

10 7 N.Y. 3d 616, 621 (2006).

11 Beirne Wealth Consulting Servs., LLC v. Englebert, No. 19 CIV. 7936 (ER), 2020 WL 506639 (S.D.N.Y. Jan. 30, 2020)

12 Kelley-Hilton v Sterling Infosystems Inc., 426 F.Supp 3d 49 (S.D.N.Y. 2019).

13 NY State Senate Bill S3937C, NY State Senate (2020), https://www.nysenate.gov/node/7677776; see also NY State Assembly Bill A05776, NY State Assembly (2020), https://nyassembly.gov/leg/?bn=A05776&term=&Summary=Y&Actions=Y&Votes=Y&Memo=Y&Text=Y&leg_video=1.

14 Ronald W. Zdrojeski et al., The evolving landscape of non-compete agreements-change is underway in New York State-could non-compete clauses become unenforceable? Lexology (2019), https://www.lexology.com/library/detail.aspx?g=222535b1-92aa-47b0-a521-27692a2bd2c4.

 

LLC. Limited liability company. Business abbreviation.

The Importance of Dissolution Provisions for New York LLCs

The limited liability company (LLC) has become one of the most commonly used business entities in New York because of the many benefits it provides to its members and managers. LLCs allow members to satisfy their business needs while still providing them with the same limited liability protection that limited partnerships provide. Although the flexibility of an LLC can be very beneficial, it is this commentator’s view that members of a New York LLC should not rely on New York’s Limited Liability Company Law (LLCL) to govern the activities of an LLC. If persons choose to form an LLC, it is essential that they have a clearly written operating agreement that provides explicit terms for, among other things, the LLC’s dissolution. A number of New York cases illustrate issues that arise when an operating agreement is vague on how to dissolve the LLC. Indeed, as discussed below, an LLC can be difficult to dissolve if the operating agreement is not explicit in this regard.

Under LLCL §702 a court may dissolve an LLC “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” In Matter of 1545 Ocean Avenue., LLC1, the Appellate Division for the Second Department articulated two factors courts in that department must consider when deciding if an LLC can be dissolved. The petitioner for the dissolution must show: (1) the management of the company is unable or unwilling to reasonably permit or promote the stated purpose of the company to be realized or achieved; and (2) continuing the company is financially unfeasible. In that case, the court found a dissolution was not justified.

Other New York cases demonstrate the obstacles LLCs can face when they do not have clear dissolution provisions in operating agreements. In Yu v. Guard Hill Estates, LLC2 the trial court did not allow a dissolution to occur when the only justification for dissolution was discord between family members. The court stated as follows: “While [the petitioner] complains that his family members have engaged in certain activities to further their personal ‘vendetta’ against him, his unflattering characterization of his family’s actions is not sufficient to support a cause of action that his family has abandoned the purpose of the LLC.” Another example when a New York court found that an LLC could not be dissolved is the case Kassab v Kasab3, where the Queens County Commercial Division denied dissolution because the “exile” of a member participating in the partnership did not satisfy either prong established in 1545 Ocean Avenue.4

However, there have been some New York cases where dissolution was allowed pursuant to LLCL §702. In Matter of 47th Rd. LLC5, the court stated that the existence of personal vendettas between two brothers who were “partners,” which threatened to result in physical violence and ruin the business, could result in a judicial dissolution. A similar result occurred in Matter of D’Errico6, after the majority members of an LLC named Epic locked out all of the minority members from the premises of the business and prevented the minority members from accessing all business accounts. The majority members even formed a new LLC called BeyondEpic. As a result of BeyondEpic having been formed, the court stated as follows: “BeyondEpic … reduced Epic to an entity that operates solely at BeyondEpic’s sufferance.” Accordingly, the court found that judicial dissolution of Epic under LLCL §702 was warranted.

As New York courts continue to establish precedents for LLCL §702, the significance of an unambiguous dissolution provision in LLC operating agreements is essential. While partners in a business at its inception are often not thinking about its demise, it is important to try to anticipate issues which should lead to a dissolution of the LLC. The cases discussed in this article exemplify how operating agreements that do not clearly delineate the grounds for dissolution can cause serious issues for persons involved in those LLCs. Simply relying on the default dissolution statute, LLCL §702, is a risk no members of a New York LLC should take.


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
Connect with me on Linkedin

 

1 Matter of 1545 Ocean Ave., LLC, 72 A.D.3d 121 (2010).

2 Yu v. Guard Hill Estates, LLC 2018 N.Y. Slip Op 32466(ii) (Sup.Ct. Sept. 28, 2018).

3 Kassab v. Kasab, 65 N.Y.S.3d 492 (N.Y. Sup. 2017).

4 Supra note 1.

5 In Matter of 47th Rd. LLC 54 N.Y.S. 3d 610 (N.Y. Sup. Ct. 2017).

6 Matter of D’Errico No. 610084 (Sup.Ct. Nassau County Aug. 21, 2018).