Tag: New York Employment Law

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

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

What is a Restrictive Covenant?

Our last blog article provided an update on the state of New York law concerning non-compete provisions. This article focuses on the state of New York law concerning restrictive covenant provisions other than non-competes. As our readers are almost certainly all well aware, a restrictive covenant is a contractual provision that many employers include in employment and severance agreements as well as in contracts with respect to the sale of a business. Such provisions are designed to limit the activities of a former employee or a former owner of a company for a fixed period of time following the end of the employment relationship or after the sale of a company to protect the former employer’s or buyer’s supposed legitimate business interests. In addition to employment, severance, and agreements concerning the sale of a business, these covenants can often be found in stock option agreements.

Enforceability of Restrictive Covenants

As is well known, New York courts generally disfavor restrictive covenants contained in employment contracts and will only enforce them when they are found to be reasonable and necessary to protect an employer’s legitimate business interests.1  The test New York courts use to determine whether a restrictive covenant is reasonable was relied on recently by the United States District Court for the Eastern District of New York in Intertek Testing Servs., N.A., Inc. v. Pennisi.2 The court stated: “[a] restraint is reasonable only if it: (1) is no greater than is required for the protection of a legitimate interest of the employer; (2) does not impose undue hardship of the employee; and (3) is not injurious to the public.” Applying this test, New York courts analyzing a restrictive covenant take a two-step approach:3

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

Scope and Duration

To be enforceable, a restrictive covenant must not be more extensive, in terms of time and place, than necessary to protect the legitimate interests of the employer. A court may find a restriction to be unreasonable when it covers a geographic area where the employer does not compete, or where the provision would effectively prevent the employee from continuing to work in a particular industry.4 For this reason, New York courts have rarely found worldwide restrictions reasonable in any context.

Legitimate Interests

New York courts have held that legitimate interests are limited to the protection against misappropriation of the former employer’s trade secrets, confidential customer lists, or protection from competition by a former employee whose services are unique or extraordinary.5 Additionally, such courts have found that an employer has a legitimate interest in protecting client relationships or goodwill developed by an employee at the employer’s expense.6

Types of Restrictive Covenants

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

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

1.  Non-solicitation Provisions

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

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

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

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

      • the uniqueness of the employee (which is difficult to establish);
      • the protection of the employer’s trade secrets or confidential information; or
      • the competitive unfairness of allowing competition that adversely impacts the employer’s goodwill.13

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

2.  No-hire Provisions

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

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

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

3.  “Garden Leave” Provisions

A “garden leave” provision is an extended notice provision that requires departing employees to give the company a certain period of advance notice when they intend to leave the company.24  It is a variation of a notice of termination provision and can be used as an alternative to or in addition to a traditional non-compete provision to restrict competition by departing employees.  Such a provision gives employers the option to pay the employee through the balance of the notice period and direct her or him not to come to work or perform services, giving the employees leave to “tend to their gardens” or pursue any other activity excluding other employment provided that the employee does not compete with her or his former employer.25 Extended notice provisions may be mutual but can also require that only the employee provide notice, with no similar obligation on the employer.26 Where mutual, these provisions without exception (to our knowledge) do not require such notice from employers where the employee is being terminated for cause.27

 


Richard B. Friedman
Richard Friedman PLLC

200 Park Avenue Suite 1700
New York, NY 10166
TEL: 212-600-9539
rfriedman@richardfriedmanlaw.com
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1 Flatiron Health, Inc. v. Carson, 2020 WL 1320867, at 19 (S.D.N.Y. Mar. 20, 2020).
2 Intertek Testing Servs., N.A., Inc. v. Pennisi, 2020 WL 1129773, at 19 (E.D.N.Y. Mar. 9, 2020).
3 Id; See also King v. Marsh & McLennan Agency, LLC, 67 Misc. 3d 1203(A) (N.Y. Sup. Ct. 2020). KCG Holdings, Inc. v. Khandekar, 2020 WL 1189302, at 17 (S.D.N.Y. Mar. 12, 2020).
4 Good Energy, L.P. v. Kosachuk, 49 A.D.3d 331 (1st Dep’t 2008).
5 Intertek Testing Servs., N.A., Inc. v. Pennisi, 2020 WL 1129773, at 21.
6 Id.
7 4B N.Y.Prac., Com. Litig. In New York State Courts § 80:8 (4th ed.).
8 Id.
9 Contempo Communications, Inc. v. MJM Creative Services, Inc., 182 A.D.2d 351 (1st Dep’t 1992). Genesee Val. Trust Co. v. Waterford Group, LLC, 130 A.D.3d 1555, 1558 (2015).
10 King v. Marsh & McLennan Agency, LLC, 67 Misc. 3d 1203(A) (N.Y. Sup. Ct. 2020).
11 Id.
12 Id.
13 Flatiron Health, Inc. v. Carson, 2020 WL 1320867, at 21 (S.D.N.Y. Mar. 20, 2020).
14 Harris v. Patients Med., P.C., 93 N.Y.S.3d 299 (N.Y. App. Div. 2019).
15 Id.
16 Vertical Sys. Analysis, Inc. v. Balzano, 621, 97 N.Y.S.3d 467 (N.Y. App. Div. 2019).
17 Marsh USA Inc. v. Karasaki, 2008 Wl 4778239 (S.D.N.Y. 2008).
18 See Intertek Testing Servs., N.A., Inc. v. Pennisi, 2020 WL 1129773, at 23 (E.D.N.Y. Mar. 9, 2020); General Patent Corp. v. Wi-Lan Inc., 2011 WL 5845194 (S.D.N.Y. 2011).
19 General Patent Corp. v. Wi-Lan Inc., Isd.
20 Oliver Wyman, Inc. v. Eielson, 282 F. Supp. 3d 684, 695 (S.D.N.Y. 2017).
21 Id.
22 Id.
23 Id.
24 4B N.Y.Prac., Com. Litig. In New York State Courts § 80:10 (4th ed.).
25 Id.
26 Id.
27 Id.

 

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

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

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

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

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

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

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

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

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

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

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

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

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

Richard B. Friedman
Richard Friedman PLLC
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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