Restrictive Covenants

 

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So you have been offered a job…What’s Next? Understanding Your Employment Agreement.

Covenant Not-to-Compete

The joyful moment of getting a job offer is often followed by a somewhat awkward stage for the prospective employees – negotiation of the proposed employment agreement. Yes, that’s right! The employment agreement that your employer will provide you, will be undoubtedly one-sided, and favoring your employer. You should not be afraid to ask questions, and negotiate on your behalf.

However, to negotiate a better deal for yourself, you need to fully understand the terms of your employment agreement. Unfortunately, many prospective employees do not look past the compensation section of their employment agreements, which albeit extremely important, is not the only part of the contract deserving close scrutiny. In this article, we are going to discuss another very important section of the employment contract — a section dealing with the covenant not to compete (or noncompetition clause). The non-competition provisions will actually affect your life after the termination of your employment. So if you think, that the worst case scenario is that you will just switch jobs, if something goes wrong, think again.

Covenant not to compete is a type of post-termination restrictive covenants that employers often include in their form employment contracts (along with the covenant not-to-solicit clients, employees, suppliers, sources of referral, etc.) to prevent a former employee from competing with the employer either directly (e.g., setting up a competing business “across the street”) or through a subsequent employment by a competitor. As a general rule New York law does not prohibit former employees from competing with a former employer, unless otherwise agreed to between the employer and the employee. For this reason, more and more employers currently include the non-competition provisions in their employment agreements.

A noncompetition clause is an agreement between an employer and an employee limiting an employee’s competitive activities for a specified period of time after the employment relationship ends. To be enforceable in New York, however, the covenant should be “reasonable” in that the restrictions must be necessary to protect a former employer’s legitimate interest (i.e., to prevent unfair competition), and the restrictions are reasonable in duration, geographic scope and substance.

The question of reasonableness of the non-competition restrictions is very fact-specific. The seminal case on the issue of enforceability and reasonableness of non-compete clauses is BDO Seidman v. Hirshberg (1999). The New York Court of Appeals has noted that “a restrictive covenant will only be subject to specific enforcement to the extent that 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.”

A different analysis is used with respect to learned professions. In BDO Seidman the Court of Appeals held that when it comes to non-competition agreements between professionals, a greater weight should be given to the interests of the employer in restricting competition within a confined geographical area. The rationale used by the court for such different analysis was that professionals were deemed to provide “unique or extraordinary” services. However, even in the context of professionals, unduly broad noncompetition agreements will not be enforced.

The New York State courts later expounded the test for reasonableness set forth in BDO Seidman, and explained that the first step is to determine whether there is a necessary and legitimate interest that the former employer seeks to protect. When there is no legitimate interest supporting a restrictive covenant in an employment agreement, the restriction will not be enforced regardless of whether the covenant is otherwise reasonable. Generally, legitimate interests of the former employer include the protection against misappropriation of trade secrets or confidential information and protection from competition by a former employee whose services are unique or extraordinary The services or skills of an employee are typically considered unique where, due to the special nature of employee’s relationship with his or her customers, there is a “substantial risk” that the employee could divert all or part of such customers’ business.

To give you some background context – in the past courts have acknowledged employer’s legitimate interest to prevent unfair competition, where the former employer supplied the former employee with substantial resources. For example, the courts have found legitimate interest, where the former employer provided financial and support services to an employee to develop customer relationships; where the former employer devoted a substantial amount of time and support to projects tailored directly to specific clients; and where the former employer substantially invested time and money in maintaining a support staff dedicated to aiding employee representatives in addressing the needs of clients.

To the contrary, where an employee’s skills are general in nature, or no special skills or training is needed for a job, then that former employee’s skills will generally not be considered unique or special (even if such employee is very experienced and effective at performing his duties).[1]

Moving on. Assuming there is a legitimate interest of a former employer, the courts will review whether the non-competition clause restrictions (e.g., territorial application, duration) are reasonable, and no greater than necessary to protect the employer’s legitimate business interest. Thus, for instance, with respect to the duration of the non-compete, the courts will assess whether the length of the non-compete is reasonable considering the totality of the circumstances, or alternatively will look to the point at which the knowledge possessed by a former employee may no longer be relevant. Generally, assuming the remainder of the covenant is enforceable, a time limitation of up to and including one year has been regarded by courts as reasonable. Under certain circumstances even covenants up to five years have been enforced. Thus, there is no bright line rule for the maximum “reasonable” length of a restrictive covenant.

As for the geographic scope of the non-compete, such covenant is likely to be enforced if the restricted area coincides with the former employer’s location, or the location where the former employer primarily provided services, or the location where the main clients and customers of the former employer are located.

The above shows that when it comes to litigating non-competes, the facts of each case will be decisive of the outcome, and the likelihood of predicting the outcome is very low. Therefore, from the prospective of both employers and employees it is better to negotiate a “fair” and acceptable deal from the outset of the employment relationship. However, employers often use this uncertainty — along with certain scare tactics — to try to stretch the limits of the reasonableness of the restrictions. Particularly, employers would include unenforceable or otherwise problematic language in the restrictive covenant section of the employment agreement, in hope to scare off the employees and their potential future employers, when faced with a threat of long-lasting, time-consuming and expensive litigation. The assumption here is that even if you are ready to fight “tooth and nail” to prove your non-competition unenforceable, your new prospective employer may not wish to be dragged into a potential litigation, or to wait until you win your battle in court.[2]

The employers, however, also should not be overly relying on these scare tactics, because if the former employee actually does end up in court litigating the former employer’s overly broad non-compete, the former employer risks not getting any protection at all (as opposed to more limited protection, had the covenant been drafted in a more reasonable fashion). Even the existence of the so-called “blue-pencil” provisions (allowing the courts to basically strike the unenforceable provisions, and in some cases re-write the remaining provisions to make them enforceable as a whole) may not necessarily prevent the court from striking the entire non-competition clause. The case on point here is a relatively recent appellate decision in Brown & Brown Inc. v. Johnson, 980 N.Y.S.2d 631 (4th Dep’t 2014).[3] In this case a former employer, Brown & Brown, Inc., sued its former employee, Theresa Johnson, and her new employer (Brown’s competitor) for violating the restrictive covenant provisions (non-solicitation of customers) of Ms. Johnson’s employment agreement with Brown. In finding that the restrictive covenant language was overbroad and unenforceable, the court not only refused to apply the choice of law provisions in the employment agreement – stating that the Florida law with respect to the restrictive covenant was “truly obnoxious” to New York public policy – but also refused to “blue pencil” the covenant to limit the scope of its application. The court noted that Brown presented the employment agreement to Johnson more than seven years after the BDO Seidman decision, which “served as notice to plaintiff that the agreement at issue here was also overly broad.” Although the agreement provided for partial enforcement if a court found the covenants overly restrictive, the court concluded that provision demonstrated that Brown imposed the covenant in bad faith, knowing that it was overbroad.

The information contained in this article only partially covers the complexity of the restrictive covenants in general, and covenants not to compete in particular. In practice, there is a lot more to it than just determining the reasonableness of the covenant. Questions have been raised regarding transferability of the non-competes (e.g., upon the change of control of the former employer), enforceability of non-competes if the employee was terminated by the employer without cause, etc. Both employers and employees should pay close attention to the restrictive covenants language in their employment contracts, understand the potential issues with enforcing such covenants, and the practical consequences of non-compliance with such post-termination employee obligations.

Viktoriya Badoeva, Esq.    vbadoeva@cebalaw.com

 


[1] However, one should be cautious when considering the “unique and extraordinary” requirement for the services provided. Do not assume that it only applies to members of “learned professions,” i.e., those professions that require extensive training and education. See, for instance, Ticor v. Cohen, holding that the services of a sales person, under the appropriate circumstances, can be deemed unique.
[2] Now please remember that, in the event you lose, the time you spent in court fighting the non-compete would not count towards the duration of such non-compete, meaning that the period of your non-compete restrictions will start running from the beginning as of the moment of judgment against you. Likewise, you would not be able to compete with the employer during the pendency of your litigation, because you most likely would be enjoined from such competition by a court order upon the motion of your former employer.
[3] In Brown, the Court was tasked with reviewing the non-solicitation of customers clause of the employment agreement. However, the analysis would be similar for purposes of determining the reasonableness of the non-competition clause.
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Restrictive Covenants

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