CATEGORY: Executive Severance and Employment-Related Agreements

The ‘Faithless Servant’ Doctrine Under Current New York Law
POSTED BY ON August 31 2022

The faithless servant doctrine allows employers to recover compensation paid to a former employee upon demonstrating that the employee engaged in disloyal and unfaithful conduct during his or her employment. This doctrine, grounded in agency law, offers protection and compensation for employers who discover wrongdoing by current or former employees, especially in situations where proving damages may be difficult. However, as discussed below, New York courts will not apply the doctrine to impose liability in the absence of specific allegations of misconduct.

Under New York state law, an employee is obligated “to be loyal to his employer and is ‘prohibited from acting in any manner inconsistent with his agency or trust and is at all times bound to exercise the utmost good faith and loyalty in the performance of his duties.’”1 Moreover, an employee has an affirmative duty to act in a manner consistent with his agency and exercise good faith and loyalty.2 The faithless servant doctrine provides that “[o]ne who owes a duty of fidelity to a principal and who is faithless in the performance of his services is generally disentitled to recover his compensation, whether commissions or salary.”3 As follows, a “principal [employer] is entitled to recover from his unfaithful agent any commission paid by the principal[,]”4& or withhold compensation for services rendered by such an employee.5 An unfaithful employee’s forfeiture of compensation is also compulsory even when the principal employer benefitted or did not suffer provable damage as a result of the breach of fidelity.6 If an employee is shown to have been repeatedly disloyal throughout their tenure, “complete and permanent forfeiture of compensation, deferred or otherwise, is warranted.” 7 Courts have demonstrated less sympathy for employees who committed illegal acts against their employers by ruling in favor of the wronged employers’ claims for compensation.8

There are two different standards used by New York courts in determining whether an employee’s conduct is covered by the faithless servant doctrine: the Turner standard and the Murray standard.9p The more stringent standard, Turner, requires a showing of “substantial” disloyalty by the employee in order for the misbehavior to warrant forfeiture.10 Under the Turner standard, employee disloyalty must consist of more than only a single act, and the employer must not have known of or tolerated the behavior.11 The second standard, first recognized by the New York Court of Appeals in Murray v. Beard,12 requires less: “a breach of a duty of loyalty or good faith,” without regard as to the severity of the breach.13 Tension remains between these two standards because New York courts have not defined the circumstances in which each standard should apply.14 Regardless of the standard utilized,15 actionable misconduct under a faithless servant theory can take many forms, including fraudulent misconduct, gross negligence, embezzlement, misappropriating trade secrets, behavior detrimental to the company, or misstating a company’s financial position.

The faithless servant doctrine is a powerful tool for employers because it provides an easier method of calculating damages than breach of contract and tortious interference claims, which require that a plaintiff demonstrate the monetary value of damages suffered. In contrast, as mentioned previously, under the faithless servant doctrine, the plaintiff need only make a sufficient showing of disloyalty committed by the former employee during his or her employment.16 This has been articulated by the New York Court of Appeals, which reasoned that the function of a breach of fiduciary duty action is not only to compensate plaintiff employers for wrongs committed by their former employees, but also to prevent such unfaithfulness “by removing from agents and trustees all inducement to attempt dealing for their own benefit in matters which they have undertaken for others[.]”17

New York law permits relaxation of the law of forfeiture by allowing apportionment. This is in alignment with the position taken in the Restatement (Second) of Agency (1958), which “calls for apportioning forfeitures when an agent’s compensation is allocated to periods of time or to the completion of specified items of work.”18 Specifically, an employee may keep compensation for the tasks performed loyally, during the time period of disloyalty in other work, where: (1) the parties agreed in the contract itself that the agent would be paid on a task-by-task basis; (2) the agent performed other certain tasks with no misconduct at all; (3) the agent’s disloyalty in other tasks “neither tainted not interfered with the completion of” the tasks for which the agent was loyal.19 While supported strongly by the Restatement, this distinguishment of Murray was also rooted in the opinion that depriving unfaithful employees of all their earnings when some tasks were completely properly would be too punitive.20 However, certain New York courts have held that former employees forfeited their entitlement to all compensation after their first disloyal act.21

For example, in Phansalkar v. Anderson Weinroth & Co., L.P., the Second Circuit held in 2003 that the faithless servant doctrine required the former employee-agent, Phansalkar, to forfeit all compensation after his first disloyal act because his agreement called for general compensation and did not itemize his compensation to specific amounts paid for completion of specific tasks.22 Phansalkar repeatedly violated his affirmative duty to act in his employer’s best interests, primarily by failing to give his employer compensation he received in cash, stocks, and other interests that should have been turned over.23Further, the court notably concluded that a specific finding of employee’s intent to defraud an employer is not required to render their misconduct sufficient to warrant forfeiture.24

In 2018, the First Department provided further support for the faithless servant doctrine by confirming an arbitration award which included disgorgement of the former employee’s past salary and commissions during the four-year period of her unfaithfulness, ordering that the former employee return a total of $2.7 million.25 In that case, Matter of Mahn v. Major, Lindsey & Africa, LLC, the court held that the award was not punitive in nature and did not violate New York’s public policy.26 Additionally, in City of Binghampton v. Whalen, the Court ordered the forfeiture of the salaried employee-agent’s entire compensation during the six-year period in which he stole money from the city, despite his prior “unblemished” thirty-five years of service to his employer.27

However, it is important to point out that employers must provide enough evidence of when and how the former employee acted unfaithfully in order to successfully invoke the faithless servant doctrine. In Rubio v. BSDM Mgmt., the Southern District of New York held in 2021 that the asserted faithless servant claim “mirror[ed] the very elements of a cause of action for fraud” so Rule 9(b) of the Federal Rules of Civil Procedure applied.28 In accordance with Rule 9(b)’s particularity requirement,29 the court dismissed the employer’s faithless servant claim because it was not plead with the required specific factual allegations.30 Similarly, in the 2020 case, Babbitt v. Keoppel Nissan, Inc., the court held that the defendants’ cross-claim that the plaintiff, a former finance manager, had been a faithless servant because the defendants failed to provide any detail beyond conclusory allegations such as “’[t]he Plaintiff’s disloyalty permeated her services in its most material and substantial part.” 31 Further, in the 2019 case of Stefanovic v. Old Heidelberg Corp., Defendants alleged in a cross-claim that Plaintiffs, former restaurant personnel, altered the gratuity amount on customers’ receipts to give themselves a higher tip and, therefore, under the faithless servant doctrine, forfeited compensation paid to them during those periods of employment32. However, because the defendants did not provide any specific instances of receipt altering by the plaintiffs, their counterclaim was dismissed.33

In sum, the faithless servant doctrine under New York law remains a potent weapon for employers to use against former employees who engaged in certain kinds of misconduct, which serves two significant purposes: deterrence for employees’ disloyalty and the court-sanctioned rewarding of meaningful monetary remedies to wronged employers. However, employers who fail to prove when and how the former employee acted disloyally should, and are likely to, have their claims dismissed in New York.


1 Western Elec. Co. v. Brenner, 41 N.Y.2d 291, 295 (1977) (quoting Lamdin v. Broadway Surface Adver. Corp., 5 N.E.2d 66 (1936)).
2 Executive Trim Construction, Inc. v. Gross, 525 F.Supp.3d 357 (Dist. Ct. 2021) (citations omitted).
3 Feiger v. Iral Jewelry, 41 N.Y.2d. 928 (1977) (citing Restatement [Second] of Agency § 469).
4 Weschler v. Bowman, 284 N.Y. 284, 292, 34 N.E.2d 322 (1941) (alteration in original).
5 Lamdin, 5. N.E.2d at 66.
6 Feiger v. Iral Jewelry, 41 N.Y.2d at 929.
7 William Flloyd Union Free School Dist. V. Wright, 61 A.D.3d 856, 859 (2009).
8 27 Am. Jur. 2d Employment Relationship § 65.
9 Phansalkar v. Andersen Weinroth & Co. L.P., 344 F.3d 184, 201 (2d Cir. 2003).
10 Id. (citing Turner v. Konwenhoven, 100 N.Y. 115, 119 , 2 N.E. 637(1885)).
11 Phansalkar, 344 F.3d at 202 (citation omitted).
12 Murray v. Beard, 102 N.Y. 505 (1886)
13 Phansalkar, 344 F.3d at 202 (citing Lamdin v. Broadway Surface Adver. Corp., 5 N.E.2d 66 (1936)).
14 Phansalkar, 344 F.3d at 202.
15 See Stefanovic v. Old Heidelberg Corp., No. 18 CV 2093-LTS-KNF, 6 (S.D.N.Y. Aug. 8, 2019) (“Interpreting these standards, courts in this circuit have held a faithless servant claim requires showing that the employee breached their duty of loyalty to their employer in a way that was substantial and material to the performance of their duties.”) (citation omitted) (providing an example of the interpretation of this tension between the two standards).
16 See Beach v. Touradji Capital Management, LP, 42 N.Y.S.3d 96, 102 (2016) (holding that former employer’s damages for breach of fiduciary duty were not limited to loss of investors).
17 City of Binghampton v. Whalen, 341 A.D.3d 145, 148 (2016) (citing Diamond v. Oreamuno, 24 N.Y.2d 494, 498 [1969] [internal quotation marks, citation and emphasis omitted]).
18 Musico v. Champion Credit Corp., 764 F.2d 102, 113 (2d Cir. 1985) (interpreting decisions regarding apportionment).
19 Phansalkar v. Andersen Weinroth & Co. L.P., 344 F.3d 184 (2d Cir. 2003) (citing Musico, 764 F.2d at 114).
20 Trounstine v. Bauer, Pogue & Co, 144 F.2d 379, 383 (2d Cir. 1944) (Judge Swan affirmed apportionment of fees so that the employee-agents lost compensation only for improperly performed tasks, reasoning that “[t]o deprive the defendants of these commissions would be mere punishment because they had violated their duty as to other transactions.”).
21 Phansalkar, 344 F.3d at 184.
22 Id. at 188.
23 Id.
24 Id. (citing Lamdin, 272 N.Y. at 137, 5 N.E.2d 66 (where employee advances his own interests by procuring due bills instead of cash and, in doing so, does harm to his employer’s interest, misconduct is sufficient to warrant forfeiture, in the absence of the employer’s acquiescence)”
25 Matter of Mahn v. Major. Lindsey, & Afr., LLC, 74 N.Y.S.3d 7, 8 (2018).
26 Id. at 8.
27 City of Binghampton v. Whalen, 341 A.D.3d 145, 148 (2016).
28 Rubio v. BSDB Mgmt., 19-CV-11880 (VSB) (S.D.N.Y. Jan 12, 2021) (citations omitted).
29 Fed. R. Civ. P. 9(b) (“in all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity.”).
30  Rubio, 19-CV-11880 (VSB).
31 Babbitt v. Koeppel Nissan, Inc., 2020 WL 3183895 (E.D.N.Y. June 15, 2020).
32 Stefanovic v. Old Heidelberg Corp., No. 18 CV 2093-LTS-KNF, 6 (S.D.N.Y. Aug. 8, 2019).
33 Id. at 8.

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Critical Issues in Negotiating Separation Agreements
POSTED BY ON April 11 2022

Whether the employment relationship ends with a celebratory retirement party after many years, dissolves upon the decision of either party after a short time, or under other circumstances, all employment relationships eventually end. This article will briefly describe some of the provisions that should be considered by employers and executives for inclusion in a separation agreement.

Stating the Last Day of Employment:

At the risk of stating the obvious, the separation agreement must identify the date on which the employment ceased or is to cease. The agreement should state that all salary, bonuses, commissions, and any other monetary benefits have been paid as of the date of the separation agreement or identify the specific amounts that are outstanding and when such payment(s) will be made.

Although a separation agreement is sometimes presented to an employee at the time of termination, it is appropriate in some employment arrangements, particularly outside of the financial services industry, for there to be a transition period during which the employee is expected to either continue performing her or his duties as usual, certain defined duties, or simply assist in the transition. If the employee’s responsibilities are being modified during the transition period, they should be specified to the extent possible.

Cooperation Provision:

Employers should generally include a provision requiring the former employee to cooperate with respect to matters relating to her or his former employment. Counsel for the former employee should modify the cooperation provision to ensure that the former employee’s obligations are to only cooperate reasonably and at times that are mutually convenient and not disruptive of any future employment. Such counsel should also insist on a provision pursuant to which the former employee will be compensated for all expenses incurred in connection with satisfying her or his cooperation obligations.

Severance Payments:

Severance payments are included in almost all separation agreements as the consideration for the general release that employers appropriately insist upon. Although severance payments are often proposed based on a number of weeks or months per years of employment, employees should generally seek to negotiate for increased monetary amounts.

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.

Bonus payments are typically forfeited by employees who are not employed on the date bonuses are paid; however, executives are sometimes able to negotiate to be paid prorated or agreed upon bonus amounts for services rendered until the termination date.

When executives have equity rights, such rights are governed by the applicable plan documents or awards and that should be stated specifically in the separation agreement. Employees generally forfeit unvested restricted stock units and stock options upon the cessation of employment. However, it is sometimes possible for executives to negotiate for the acceleration of certain unvested restricted stock units or stock options.

Continued Health Insurance:

As is well known, former employees of companies which employed at least 20 employees on more than 50 percent of its typical business days in the previous calendar year are always entitled to continued health insurance through COBRA for a period of 18 months or longer under certain circumstance. Separation agreements often require the former employer to pay COBRA premiums for an agreed upon period of time or until the former employee becomes eligible for other insurance through a new employer in which event the agreement should require the former employee to provide notice to the former employer.

Company Property and Confidentiality Agreement:

All separation agreements should contain a provision pursuant to which the former employee confirms that all property of the company or any of its affiliates, such as computers, key cards, company credit cards, contacts, notes, files, software, and any confidential information, has been returned or specify a date by which they will be returned and, if appropriate, how that it is to be accomplished logistically.

Confidentiality agreements, usually executed by employees when joining a firm, prevent employees from disclosing proprietary company information both during and after the employment ends. Any such agreement which is in place should be cited in the separation agreement. If an employee is not already subject to a confidentiality agreement, there should be a confidentiality provision in the separation agreement. In the view of this commentator, it is almost always in the interests of the former employee to seek to have the confidentiality obligations be mutual so that the former employer cannot disclose the circumstances of the separation.

Counsel for employers should consider including a provision in all separation agreements which entitle the former employer to claw back severance payments and cease making any additional installment payments in the event that the former employee has breached any provision of the agreement. Counsel for employers sometimes include a provision exempting a small amount of the severance payment from the claw back in the hope of avoiding an argument that the claw back eliminated the consideration pursuant to which the former employee released all claims and that the release is therefore unenforceable.

Company Responses to Inquiries and Reference Letters:

Separation 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. It is often in the best interests of both parties for the separation agreement to 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.

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 separation 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 separation agreement with a provision that the company must make it available exclusively in response to any inquiries about the former executive.

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

Releases:

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 former 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 argument that, mindful of his improper conduct, the former employee fraudulently induced the company into signing the separation 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.

Non-Disparagement Provisions:

This commentator believes that counsel for a former employee should generally seek to have the non-disparagement provision in virtually all separation agreements be mutual. In those instances where company counsel refuses to do so, the following approach should 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 several 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.

Importance of Separation 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. Separation 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 Separation Agreements to Former Employees:

In addition to receiving severance compensation, which sometimes also includes the acceleration of certain restricted stock units or stock options and company payment of COBRA insurance premiums for an agreed upon period of time, former employees can benefit from entering into a separation 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 by the former employer in response to inquiries about the former employee; and (iv) limits on the former employee’s obligations to cooperate with her or his former employer in connection with matters concerning her or his former employment.

Of course, every situation is different. We regularly counsel senior and mid-level 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
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Is the CFAA Violated when an Employee Accesses Authorized Information for an Improper Purpose?
POSTED BY ON October 18 2021

 

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
www.richardfriedmanlaw.com/blog
Connect with me on Linkedin

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Defend Trade Secrets Act of 2016: A Five Year Overview
POSTED BY ON June 23 2021

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
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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
POSTED BY ON January 27 2021

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
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www.richardfriedmanlaw.com
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Issues Arising in Negotiating Severance Agreements by Richard B. Friedman
Issues Arising in Negotiating Severance Agreements
POSTED BY ON August 4 2020

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
POSTED BY ON June 22 2020

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
Connect with me on Linkedin

____________________

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
POSTED BY ON May 12 2020

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
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____________________

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
POSTED BY ON March 18 2020

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
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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).

tug of war between businessmen
A New York Corporate Dissolution Saga
POSTED BY ON August 30 2019

Corporate dissolution proceedings in New York are governed by strict procedural rules. When litigation is pending between the owners of one or more closely held companies, it is not uncommon in my experience for the defendant(s) to want to assert a counterclaim seeking dissolution of the relevant corporation(s). However, filing a separate dissolution proceeding is generally a better tactical move. A would-be dissolution petitioner recently found this out the hard way.

In Corner Furniture Discount Ctr., Inc. v Sapirstein, two partners had formed a retail furniture business in the 1980s, which later expanded into four corporations: two furniture entities and two real estate holding companies. In 2018, after discovering that his partner Sapirstein had apparently been embezzling funds for many years, Stechler removed Sapirstein as an officer and director of the business and barred him from decision making. The furniture entities sued Sapirstein alleging claims for breach of fiduciary duty, fraud, conversion, and violation of the faithless servant doctrine.

Sapirstein filed an answer and alleged counterclaims against all four entities, including a claim for dissolution based on “oppression” and “waste” under Section 1104-a of the Business Corporation Law (the “BCL”). 

The four entities filed a motion to dismiss Sapirstein’s dissolution counterclaim as procedurally defective and non-compliant with BCL Sections 1105 and 1106. Section 1105 requires a party suing to dissolve a corporation to file a “petition for dissolution,” which Sapirstein had not done. Section 1106 requires a party suing to dissolve to file the petition by “order to show cause,” outlining very specific procedures the court and petitioner must follow once the order to show cause is filed. 

These specific procedures include: 

  • “the order to show cause must require the corporation and all interested persons to show cause not less than four weeks after the granting of the order, why the corporation should not be dissolved;
  • the court may order the corporation, officers, and directors to produce to the court a schedule of pertinent information, including corporate assets and liabilities, and the name and address of each shareholder, creditor, and claimant;
  • the petitioner must publish the order to show cause at least once in each of the three weeks prior to the return date of the order to show cause in a newspaper of general circulation in the county where the corporation’s principal office is located;
  • the petitioner must serve the order to show cause upon the state tax commission, the corporation, and each person named in the petition, or in any schedule of shareholders, creditors, or claimants at least ten days prior to the return date of the order to show cause, or if served by mail, at least 20 days before the return date; and
  • the petitioner shall file the order to show cause and the petition with the clerk of the county where the office of the corporation is located within ten days after the order is entered, and shall file the schedule of information required by the court, if any, 10 days thereafter.”

Sapirstein’s dissolution counterclaim complied with none of these procedures. After discovering his error, Sapirstein attempted to belatedly file an order to show cause, petition, and declaration for dissolution. In his decision, the Judge noted that a “proponent of dissolution must comply with Business Corporation Law 1105 and 1106” and “[t]here must be strict compliance with the procedures set forth” in the statutes. The court cited, among other decisions, In re WTB Properties, Inc. In WTB, the Second Department had held that the trial court erred in ordering dissolution before the petitioner satisfied the requirements of BCL 1106. The Court also held that the lower court had the discretion to allow the petitioner to “amend the petition and comply with the statutory requirements.” Sapirstein’s error in not seeking leave to amend his pleading as an answer/petition was fatal. As the Court held, “Sapirstein’s efforts to correct his defective first counterclaim with a Petition and declaration in support, fail as they do not comply with Business Corporation Law §§ 1105 and 1106. Absent from Sapirstein’s submission are an Order to Show Cause, a Verified Petition, and proof of publication. Sapirstein fails to plead a cause of action in compliance with the dictates of Business Corporation Law §§ 1105 and 1106″ (citations omitted). As a result, the court dissolved Sapirstein’s dissolution claim.

Sapirstein went on to bring a separate proceeding in Bronx County Supreme Court for judicial dissolution of the businesses. This petition was essentially a carbon copy of the one he had filed for Corner Furniture just over a week earlier. The court refused to sign his order to show cause a whopping four times, each for a different procedural failure, including:

  • Failure to include the affidavit and exhibits upon which the petition was based.
  • The order to show cause provided insufficient basis for the relief sought.
  • Failure to comply with the notice requirement of 22 NYCRR 202[.7] (f) which requires the movant to show that a “good faith effort has been made to notify the party against whom the temporary restraining order is sought of the time, date and place that the application will be made in a manner sufficient to permit the party an opportunity to appear in response to the application.”
  • Failure to comply with the prior notice requirement of 22 NYCRR 202.7 (f).

The Court granted Sapirstein’s fifth proposed order to show cause, but only to the extent of ordering an appearance. The court also reassigned the proceeding to Justice Franco, the same justice who dismissed Sapirstein’s dissolution counterclaim in Corner Furniture.

It seems apparent that Sapirstein would have been better off filing a separate dissolution proceeding than asserting a counterclaim seeking dissolution. He could have eventually filed a motion to consolidate the two cases.

As this case illustrates, when filing a dissolution proceeding in New York, the statutes and applicable court rules must be strictly complied with so as to avoid an embarrassing and expensive loss on procedural grounds. 

Richard Friedman
Richard B. Friedman
Richard Friedman PLLC

200 Park Avenue Suite 1700
New York, NY 10166
TEL: 212-600-9539
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1 2019 NY Slip Op 32245(U) [Sup Ct Bronx County June 14, 2019].

2 A discussion of the corporate machinery by which Stechler was able to effectuate these changes in corporate governance are beyond the scope of this article.

3 New York Consolidated Laws, Business Corporation Law, BSC § 1105.

4 New York Consolidated Laws, Business Corporation Law, BSC § 1106.

5 Id.

6 291 AD2d 566 [2d Dept 2002].

7 Id.

Background concept wordcloud illustration of arbitration
NY Business Divorces: Rights of Minority Partners and Minority Members in LLCs
POSTED BY ON July 22 2019

 

Minority members in New York limited liability companies (“LLCs”) often did not prevail in actions brought under section 702 of the New York LLC Law for judicial dissolution. One of the reasons was that the statute’s “not reasonably practicable” requirement for dissolution was interpreted by many courts to require a showing of the LLC’s failed purpose or financial failure. Oppression, fraud, and other overreaching conduct by the majority directed at the minority were not considered grounds for dissolution. Similarly, minority partners have often faced substantial obstacles in seeking to dissolve New York partnerships.

Over the last year, several New York courts have evaluated the rights of minority members seeking to dissolve a New York LLC and minority partners seeking to dissolve a partnership. Below, we will examine two of those cases.

Minority Partner’s Attempt to Dissolve a Partnership Backfires as New York’s Highest Court Approves Discount-Laden Valuation of Departing Partner’s Interest

In Congel v. Malfitano, 31 N.Y.3d 272 (2018), a minority partner engaged in a unilateral attempt to dissolve a commercial real estate partnership by written notice under Partnership Law §62. His majority co-partners immediately sued for damages resulting from an alleged wrongful dissolution under their partnership agreement, which provided that a voluntary dissolution could only be accomplished by a majority vote. The majority of partners ultimately prevailed on liability. A trial was held to determine the value of the wrongfully withdrawn partner’s interest under Partnership Law §69.

The trial court began its analysis with a stipulated value of the minority partner’s interest of $4.85 million, then deducted approximately $4 million in damages and discounts, including a 35% Discount for Lack of Marketability (“DLOM”). The majority partners sought an additional 66% Discount for Lack of Control (“DLOC”), but the trial court rejected their argument based on longstanding case law prohibiting the application of DLOC in fair-value proceedings under BCL §§623 and 1118.

On appeal, the Second Department ruled in favor of the majority partners, distinguishing the case law applying the “fair value” standard in the corporation context from the “fair market value” standard applicable to partnership interests under Partnership Law §69. The Appellate Division consequently discounted the minority partner’s interest by an additional 66% which resulted in a diminution of the value of his interest by hundreds of thousands of dollars. The court’s actions should serve as a cautionary tale to minority partners who attempt to cash out their interests by wrongfully dissolving a partnership when the remaining partners wish to continue the venture.

On appeal, the Court of Appeals affirmed and held that the prohibition of DLOC in fair-value proceedings under BCL §§623 and 1118 did not apply in the context of Partnership Law §69, which “does not contemplate a valuation of the entire business as if it were being sold on the open market, but rather a determination of the fair market value of the wrongfully dissolving partner’s interest as if that interest were being sold piecemeal and the rest of the business continuing as a going concern.”1 Such an interest, New York’s highest court held, “is worthless to anyone buying that interest alone.”2 The Court of Appeals, therefore, affirmed the Appellate Division’s application of 35% marketability, 66% minority, and 15% goodwill discounts, which collectively erased around 80% of the stipulated top-line valuation.

Even more notable than its use of multiple valuation discounts was the high court’s adoption of a contract-centric approach to the wrongful dissolution issue. The trial court and the Appellate Division had both held that the partnership was not at-will and that the minority partner had wrongfully sought to dissolve it under Partnership Law §62; the trial court’s reasoning was that the partnership agreement specified a “particular undertaking,” and the Appellate Division’s reasoning was that the agreement specified a “definite term.” The Court of Appeals came to the same conclusion but dispensed with the at-will analysis under the statute, determining instead that “Partnership Law §62 has no application here, because the parties to the agreement clearly specified under what terms [the partnership] could be properly dissolved, i.e., what would constitute a dissolution under the agreement and what would constitute a dissolution in contravention of it.”3

Instead of focusing, as did the lower courts, on whether the partnership met Partnership Law § 62 (1) (b)’s durational criteria of “definite term” or “particular undertaking,” the Court of Appeals decided the wrongfulness of the minority partner’s unilateral dissolution without recourse to the statute, and instead employed a purely contractual approach in affirming the lower courts’ finding of wrongful dissolution based on the partnership agreement’s “clear and unequivocal terms” providing the exclusive means by which the partnership could be dissolved.

This contract-centric approach to the question of wrongful dissolution offers a new mode of analysis and suggests new drafting solutions for transactional lawyers who opt to form partnerships under New York law.

LLC Dissolutions: A Path to Victory for Minority Members

LLC dissolutions involve a standard that differs sharply from the traditional standards of deadlock and oppression associated with corporations. Ever since the Second Department’s seminal 1545 Ocean Avenue decision in 2010, which expressly divorced LLC Law §702 from the law as it had developed under Business Corporation Law §§11044 and 1104-a, dissolution of an LLC has required the petitioning member of an LLC to show either that (1) management is unable or unwilling to promote the business to achieve its stated purpose, or (2) continuing the business is financially unfeasible.5

In Matter of D’Errico, Decision & Order, Index No. 610084/2016 (Sup Ct. Nassau County, Aug. 21, 2018), the Nassau County Commercial Division analyzed 1545 Ocean Avenue’s standard to find that the subject company had been relegated to a “puppet” company, and that its continued existence was therefore rendered meaningless by the majority members’ misconduct. Matter of D’Errico involved a company named Epic Gymnastics, LLC (Epic), which was formed to operate a local gymnastics and exercise facility. The parties never entered into an operating agreement for Epic, but testimony during the trial demonstrated that the purpose of the company was to “jointly operate a high-quality gymnastics facility” whose purpose later was expanded to include other exercise classes. Epic soon racked up debt, much of it personally incurred and guaranteed by one of the minority petitioners. The majority of respondents locked the petitioners out of the company’s facility and bank account and formed a related company called BeyondEpic in which petitioners had no ownership interest. BeyondEpic began collecting monies from Epic’s customers, depositing the funds into Epic’s account, and utilizing the facility from which the petitioners had been excluded.

Following a trial on the dissolution claim, in which the minority member had sued under §702, Nassau Commercial Division Justice Timothy S. Driscoll ordered dissolution, finding that “it appears that BeyondEpic has reduced Epic to a marionette to be manipulated at will by BeyondEpic,” and that it was, therefore “nihilistic for [Epic] to continue.” At the conclusion of his ruling, Justice Driscoll notes the Second Department’s endorsement of equitable buy-out in Mizrahi v. Cohen6 and invites the respondents to apply to the Court to buy out the petitioners’ interest in Epic.

Richard Friedman
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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1 31 N.Y.3d 272 at 296.
2 Id.
3 Id. at 883.
4 New York’s Business Corporation Law (“BCL”) provides shareholders owning 50% or more of a corporation two paths to judicial dissolution: a) BCL § 1104 – deadlock at the board or shareholder level such that the corporation “cannot continue to function effectively, and no alternative exists but dissolution”; and b) BCL § 1104-a – where directors or those in control of the corporation have been guilty of illegal, fraudulent, or oppressive actions toward the complaining shareholder(s).
5 In re 1545 Ocean Ave., LLC, 72 A.D.3d 121 (2d Dept. 2010).
6 2013 NY Slip Op 02056 (2d Dept Mar. 27, 2013). In this case, Mizrahi and Cohen were 50% members of a real estate company whose operating agreement required unanimous consent for capital calls. Cohen repeatedly “borrowed” hundreds of thousands of dollars from the company for personal debts, which he did not repay, exacerbating the LLC’s insolvency. In its opinion, the Second Department altered equitable buyouts from a remedy the court sometimes may order to one the court sometimes must order.


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
POSTED BY ON June 4 2019

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
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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 Law3
POSTED BY ON April 15 2019

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
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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).

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5th Annual Employment Law Institute
POSTED BY ON February 28 2019

Richard Friedman PLLC is pleased to announce ​that Rich will be serving as the lead panelist at two CLE programs at the NYC Bar Association’s 5th Annual Employment Law Institute ​on March 8, 2019​. The panel discussions will provide a comprehensive overview of the recent trends, developments, and emerging issues in employment law. Rich is organizing programs entitled “Litigating Wrongful Termination Claims,” “Critical Issues in Executive Compensation and Severance Agreements,” and the plenary session entitled “New Strategies For Conducting Sexual Harassment Investigations and Litigation” and will serve as the lead panelist on the latter two programs.

(more…)

5TH ANNUAL EMPLOYMENT LAW INSTITUTE by Richard Friedman
Employer Best Practices for Conducting Sexual Harassment Investigations
POSTED BY ON January 28 2019

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. FriedmanRichard 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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Clawing Back Compensation from a Sexual Harassment Predator in the #MeToo Era
POSTED BY ON September 11 2018

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
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TEL: 212-600-9539
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www.richardfriedmanlaw.com
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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
POSTED BY ON July 25 2018

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
www.richardfriedmanlaw.com/blog
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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*
POSTED BY ON May 15 2018

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
POSTED BY ON February 2 2018

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
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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
POSTED BY ON December 5 2017

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

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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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
POSTED BY ON July 24 2017

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
POSTED BY ON June 12 2017

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
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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
POSTED BY ON May 1 2017

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. FriedmanRichard B. Friedman
Richard Friedman PLLC
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Social Media Policies and the NLRB by Richard Friedman
Social Media Policies and the NLRB
POSTED BY ON March 27 2017

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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Issues Arising in Negotiating Severance Agreements by Richard B. Friedman
Issues Arising in Negotiating Severance Agreements
POSTED BY ON February 27 2017

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
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New York, New York 10022
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Defend Trade Secrets Act of 2016 by Richard Friedman
Defend Trade Secrets Act of 2016
POSTED BY ON October 24 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
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New York, New York 10022
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Employer Social Media Practices/Policies and the NLRA by Richard Friedman
Employer Social Media Practices/Policies and the NLRA
POSTED BY ON September 7 2016

In recent years, as the use of social media has exploded, the National Labor Relations Board (“NLRB”) has received allegations of improper discipline of employees for social media postings as well as complaints condemning employer social networking policies. We briefly discuss a few of those decisions below.

In what came to be known as “the first Facebook case,” American Medical Response of Connecticut, Inc., No. 34-CA-12576, an employee criticized her supervisor in a Facebook post for denying her Union representation, which triggered responses from co-workers voicing their support. The employee was suspended the following day and later discharged. The NLRB alleged in a complaint that the employer’s internet and social media policies were overly broad and violated Section 7 of the National Labor Relations Act (the “NLRA” or “Act”), which gives employees the right “to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection.” The NLRB’s complaint also alleged that the employee was unlawfully terminated for engaging in protected concerted activity when she posted on Facebook. The NLRB stressed that employees must be permitted to discuss the terms and conditions of their employment with co-workers. The NLRB asserted that the employer violated the NLRA when it discharged the employee for posting comments on Facebook that prompted support from other employees. The case settled when the employer agreed to substantially narrow the scope of its social media policies.

The NLRB addressed whether an employee could be fired for selecting the “like” option on a Facebook post in Three D, LLC d/b/a Triple Play Sports Bar and Grille, 361 NLRB No. 31. The NLRB found that the employer, a bar and restaurant, violated Section 8(a)(1) of the NLRA by unlawfully discharging two employees for their protected, concerted participation in a Facebook discussion in which they criticized perceived errors in their employer’s tax withholding calculations because such communications constituted concerted activities protected by the NLRA.

One of the discharged employees was terminated for “liking” a Facebook post by a former employee containing the discussion. Another employee used an expletive to describe the company co-owner. In finding the terminations unlawful, the NLRB stated that the test set out in Atlantic Steel, 245 NLRB 814, by which the Board determines whether an employee loses the Act’s protection for contemptuous workplace conduct that occurs during an otherwise protected activity, is not well-suited to address statements involving employees’ off-duty, off-site use of social media to communicate with other employees. Under the Atlantic Steel test, the Board balances the following four factors to determine whether an employee loses the Act’s protection:

1. the place of the discussion;
2. the subject matter of the discussion;
3. the nature of the employee’s outburst; and
4. whether the outburst was provoked by the employer’s unfair labor practices.

The Board stated that the first factor alone supported its conclusion that the Atlantic Steel framework should not be applied to the type of employee activities in this case.

Instead, the NLRB applied the tests articulated by the U.S. Supreme Court in the Jefferson Standard (346 U.S. 464(1953)) and Linn (383 U.S. 53 (1966)) cases to the employees’ comments. In Jefferson Standard, the Court had upheld the discharge of employees who publicly attacked the quality of their employer’s product and practices without tying such criticisms to a pending labor controversy. In Linn, the Court had limited state law remedies for defamation during a union-organizing campaign to those situations where the plaintiff could show that “the defamatory statements were circulated with malice” and caused damage. Linn v. Plant Guards Local, 383 U.S. at 64-65. Here, the NLRB concluded that the employees’ statements were neither disloyal nor defamatory under those standards because they neither disparaged the employer’s products or services or undermined its reputation and therefore did not lose the Act’s protection.

The Board also held that the company’s internet/blogging policy, which stated that “engaging in inappropriate discussions about the company, management, and/or co-workers” might constitute a violation of the law “and is subject to disciplinary action, up to and including termination of employment,” was overly broad and unlawfully restricted employees in the exercise of their rights under the Act.

The NLRB has also found that employees can lose protection under the NLRA if their conduct advocates insubordination. In Richmond District Neighborhood Center, 361 NLRB No. 74, the NLRB held that employees who engaged in specific discussions of planned insubordination on Facebook lost the protection they otherwise would have enjoyed under the NLRA. After two employees detailed their plans to disrupt the workplace and flaunted their disregard for their employer’s policies and procedures on Facebook, the discussions were reported by a co-worker who took screenshots of their exchange. Although the NLRB found the employees’ Facebook posts to be a concerted activity, the Board concluded that the employees had lost the protection of the NLRA since their statements advocated insubordination. The NLRB also considered the protracted length of the exchange between the employees and the detailed nature of the specific acts they advocated when determining that their statements had lost protection.

Richard B. Friedman
Richard Friedman PLLC
830 Third Avenue, 5th Floor
New York, New York 10022
TEL: 212-600-9539
FAX: 212-840-8560
rfriedman@richardfriedmanlaw.com
www.richardfriedmanlaw.com
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Non-compete Agreements Under New York Law by Richard Friedman
Non-compete Agreements Under New York Law
POSTED BY ON July 20 2016

Many employers try to limit former employees’ actions at the conclusion of the employment relationship through restrictive covenants. A restrictive covenant is a contractual agreement restricting the post-employment activities of a former employee for a fixed period after the termination of an employment relationship in order to protect the employer’s legitimate business interests.

A. Protectable Interests

Non-compete agreements offer the widest range of protection for employers by limiting a prior employee’s ability to work for a competitor after the employment relationship ends. However, this type of restrictive covenant is often the most difficult to enforce and is generally disfavored in New York. 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:

1) trade secrets;

2) confidential customer relationships; and

3) confidential customer information.

For example, in Ticor Title Ins. Co. v. Cohen, 173 F.3d 63, 71 (2d Cir. 1999), the court noted that an employer has sufficient interest in retaining its current customers to support a covenant not to compete where the employee’s relationship with the customers is such that there is a substantial risk that the employee may be able to divert all or part of the business.

B. Temporal and Geographic Restrictions

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 geography is limited. In Novendstern v. Mount Kisco Med. Grp., 177 A.D.2d 623, 576 N.Y.S.2d 329 (1991), the court found that a covenant restricting a physician from competing with his previous employer was enforceable because the prohibition on the physician’s practicing in his specialties for three years was in a limited geographic area.

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 world for ten years following employment at center, was unenforceable since it was unreasonable in terms of duration and geographic scope.

C. Consideration

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).

D. Selling a Business and Preparing to Compete

New York courts are most likely to enforce non-compete agreements that are incidental to the sale of business. See Mohawk Maint. Co. v. Kessler, 52 N.Y.2d 276 (1981) (stating that courts give covenants not to compete made in connection with the sale of a business and its accompanying goodwill “full effect when they are not unduly burdensome”).

New York courts have held that an employee preparing to compete violates a non-compete provision where affirmative steps have been taken that would give the individual a head start on competing once the restricted period ends. For example, in World Auto Parts, Inc. v. Labenski, 217 A.D.2d 940 (4th Dep’t 1995), the court found that conduct such as making personal loans to the principal owners of competitors and divulging to competitors price information acquired while working with the former employer constituted preparatory behavior that violated the non-compete agreement. However, in some instances, employees may prepare to compete prior to their departure provided that they do not use their employers’ time, facilities or proprietary secrets to do so. See Stork H & E Turbo Blading, Inc. v. Berry, 932 N.Y.S.2d 763 (2011).

Of course, we are available to assist in drafting, negotiating, and, if necessary, litigating non-compete and other restrictive covenant agreements. Some of the negotiated and litigated employment-related matters that our lawyers have handled in recent years have involved fiduciary duty claims, allegations of possible officer and/or employee misconduct, the faithless servant doctrine, wrongful discharge claims, confidentiality provisions in employment and severance agreements, trade secrets, and related matters.  One of Richard Friedman’s most noteworthy trial victories in the New York County Commercial Division, on whose Advisory Committee he serves with the nine judges of that court as one of about fifteen judicially appointed private practitioners, is the subject of a feature American Lawyer article that is available upon request via email at rfriedman@richardfriedmanlaw.com.

Richard B. Friedman
Richard Friedman PLLC
830 Third Avenue, 5th Floor
New York, New York 10022
TEL: 212-600-9539
FAX: 212-840-8560
rfriedman@richardfriedmanlaw.com
www.richardfriedmanlaw.com
www.richardfriedmanlaw.com/blog
Connect with me on Linkedin

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