Manager’s Services Not Unique Enough to Warrant Enforcement of Non-Compete

August 7th, 2013

A recent case in Supreme Court, New York County, addressed the issue of whether the services provided by the employee to be enjoined were unique such that an injunction was warranted. In OTG Management, LLC v. Konstantinidis, 967 N.Y.S.2d 823 (N.Y. Sup. Ct. 2013), a provider of food and beverage services at airports tried to prevent a former “terminal director,” Konstantinidis, from working for a competitor. 967 N.Y.S. 2d at 824. When OTG hired Konstantinidis, the company required him to promise that if he left OTG he would not work for “a competitor at any airport in the United States” for a full year after leaving. Id. Shortly after being promoted from an “Operations Manager” at LaGuardia to a “Terminal Director” at JFK, Konstantinidis left OTG and began working for a direct competitor, SSP, at a neighboring JFK terminal. Id.

OTG sued Konstantinidis and SSP to try to enforce the non-compete agreement and prevent Konstantinidis from working for SSP. The judge conducted the standard reasonableness test for non-compete agreements and focused on whether Konstantinidis’ services were “unique or extraordinary.” Konstantinidis, 967 N.Y.S.2d at 825. In determining that the non-compete clause was unenforceable, the judge explained that Konstantinidis’ services “were not unique nor is a Terminal Director considered a learned profession.” Konstantinidis, 967 N.Y.S.2d at 825. Furthermore, though OTG was concerned that in working for SSP Konstantinidis would divulge their trade secrets, the court explained that it would be unlikely that his status as a food service manager would require him to disclose or utilize the trade secrets at issue. Konstantinidis, 967 N.Y.S.2d at 825-26.

Konstantinidis reminds us that as much as businesses wish to restrict competition by departing employees, courts disfavor agreements that are unreasonable restraints on the free flow of labor. When employees do not perform a unique service or rely on specialized knowledge, and whose career success was not the product of a significant time or money investment by the original employer, a court will be very reluctant to allow the employer to prevent that employee from changing jobs.

Leading New York Appellate Restrictive Covenant Cases

August 7th, 2013

As courts historically have disfavored broad restraints on competition, judges tend to strictly scrutinize restrictive covenants when employers seek to enforce them. See BDO Seidman v. Hirshberg, 93 N.Y.22d 382, 389 (N.Y. 1999).

For a quarter of a century, courts in New York adhered to the standard set by Reed, Roberts Assoc. v. Strauman, 40 N.Y.2d 303, 307-08 (N.Y. 1976), which balanced two policy considerations: protecting an individual’s ability to earn a living and the reasonable interests of employers. Because restrictive covenants are subject to an overriding standard of reasonableness, they “will only be subject to specific enforcement to the extent that they are 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.” Id. Legitimate interests of the employer, according to the Reed, Roberts court, would include the protection of trade secrets or confidential information, or preventing competition when “an employee’s services are unique or extraordinary.” Id. at 308.

While attempting to remain faithful to the Reed, Roberts standard, two more recent cases refined restrictive covenant analysis for the new millennium. BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 388 (1999), and Ticor Title Ins. Co. v. Cohen, 173 F.3d 63 (2d Cir. 1999), led the way in defining how state and federal courts in New York would analyze, apply, and enforce restrictive covenants.

BDO Seidman concerned a restrictive agreement between the accounting firm BDO and Hirshberg, a manager in its Buffalo office. BDO Seidman, 93 N.Y.2d at 387. When BDO promoted Hirshberg to manager, it had required him to agree to compensate BDO for losses and damages in the event that he left the company and “served any former client of BDO’s Buffalo office” within 18 months. Id. at 387. After Hirshberg terminated his employment, the company sued, claiming damages because of 100 clients allegedly lost to Hirshberg. Id. at 388. The Court of Appeals of New York devised a three-prong test to determine whether a non-compete was reasonable in time and scope and warranted specific enforcement. Id. First, it could be no greater than required for the protection of the legitimate interest of the employer. Id. Second, the agreement could not “impose undue hardship on the employee.” Id. 388-389. Finally, the agreement would be null if “injurious to the public.” Id. at 389.

The BDO Seidman court found that the covenant at issue was reasonable because it only applied for eighteen months and only in the city where Hirshberg worked for BDO. However, while on the one hand it was legitimate for BDO to restrain a former employee from soliciting and taking clients that “BDO enabled [Hirshberg] to acquire through his performance of accounting services for the firm’s clientele during the course of his employment,” and for which he was compensated, BDO could not prevent its ex-employee from soliciting clients with whom he did not develop a relationship “through assignments to perform direct, substantive accounting services.” Id. at 391-392. Going forward then, employers have not been able to enforce those aspects of restrictive covenants which prevent ex-employees from doing business with the employer’s former clients that the employees acquired themselves (without the help of the business) or with whom the employee did not have a previous relationship. See id. at 393.

BDO Seidman v. Hirshberg was also significant because it embraced the concept of partial enforcement. Id. at 393. That is, the court rejected a rule that would nullify entire non-compete agreements because one clause or section was too broad or against public policy. Id. at 394. Therefore, post-BDO Seidman, a court could simply alter the terms of the restrictive covenant to make it more fair and reasonable under the circumstances, e.g., reducing the terms of a non-compete from one year to three months.

Some courts, however, have resisted the BDO Seidman standard of partial enforcement where the agreements were truly over-the-top. For example, in Scott, Stackrow & Co., C.P.A.’s, P.C. v. Skavina, 9 A.D.3d 805, 807, 780 N.Y.S.2d 675 (N.Y. App. 2004), a restrictive covenant that had no geographic limitations and sought to prevent the defendant “from soliciting or performing work for any client of the employer,” not just those clients with whom the employee had worked at her former employer, was found to be overly broad. Furthermore, the employer had acted anti-competitively by requiring the defendant to sign the agreement when it hired her and sign another one later as a condition of continued employment. Id. at 807. She did not enjoy any additional benefits in exchange for signing the agreement, and had to sign it again even after the BDO Seidman court placed limits on restrictive covenants. Id. at 808.

Ticor Tile Ins. Co. v. Cohen, 173 F.3d 63 (2d Cir. 1999), was a pivotal Second Circuit case, which held that an employee’s special relationships with his or her clients can be considered a unique service that warrants enforcement of a restrictive covenant. The court explained that when analyzing these agreements, trial courts should inquire into the “employee’s relationship to the employer’s business to ascertain whether his or her services and value to that operation may be said to be unique, special or extraordinary,” not just analyze the employees abilities in a vacuum. Id. at 65. Thus, a title insurance company was able to enforce a restrictive covenant against a former salesman because of the unique services that salesman had provided. The court reasoned that because “the costs and terms of title insurance are fixed by law, competition for business relies more heavily on personal relationships.” Id. at 71.

Despite Ticor Title’s holding, there are limits to what can be considered unique or special services. For example, it was unreasonable to enforce a restrictive covenant that would bar a conference organizer for two years from offering to any employer similar to her former employer anywhere in the world because “[a] conference organizer—who coordinates hotels, caterers, and printers and who makes about $50,000 a year—does not provide the ‘special, unique, or extraordinary’ services that would justify injunctive relief.” AM Medica Communications Group v. Kilgallen, 90 Fed. App’x 10, 11 (2d Cir. 2003).

The employee choice doctrine is a rare exception to the rule that courts will stringently analyze restrictive covenants. It “applies in cases where an employer conditions receipt of postemployment benefits upon compliance with a restrictive covenant.” Morris v. Schroder Capital Mgt. Int’l, 7 N.Y.3d 616, 620-21, 859 N.E.2d 503 (N.Y. 2006). That means that if an employee can choose between not competing and forfeiting rights to postemployment benefits (e.g., severance) by competing, the agreement is per se reasonable, since it an assumes the departing employee is making an informed decision. Id. at 621. In these cases, as long as the employee has terminated his employment voluntarily, courts will not scrutinize these agreements for reasonableness. Id.

Ultimately, a court’s decision to enforce a restrictive covenant will usually depend on the specific facts of the case. In particular, courts will analyze the industry, the employer, the bargaining situation leading to the agreement, and, most crucially, the terms of the agreement itself. While courts may find these agreements reasonable in many situations, those employers who overreach or try to place restraints that are too broad will lose their ability to restrain departing employees from competing, soliciting clients, or raiding coworkers. Crafters of these agreements must seek to balance the rights of a company to protect its legitimate business interests and the rights of an individual to seek work and earn a living.

Advice for Registered Representatives: Six Lessons from Cases Implicating the Protocol for Broker Recruiting

August 3rd, 2013

The Protocol for Broker Recruiting governs the employment transitions of registered representatives of financial firms, broker-dealers, and wire-houses. Signed with the stated goal of ensuring client privacy while enabling client freedom of choice, the Protocol allows a departing representative to take certain limited client information to his or her new firm. The departing representative can then immediately solicit past clients so long as both the former and hiring firm are signatories to the Protocol, the departing representative does not begin to solicit his or her clients before resigning, and the departing representative leaves behind a list of the information he or she has taken.

Because the Protocol, to which over 900 entities are signatories, trumps non-solicitation covenants, it has enabled smooth transitions for registered representatives while substantially reducing litigation. However, lawsuits between a former firm and its departing employee and/or its hiring firm may implicate the Protocol. Questions might arise about whether the employee or its new firm has breached the Protocol and about whether the Protocol should apply at all. Here are six lessons we’ve learned from those cases.

1. Courts look favorably on those departing employees who act in good faith.

When a Protocol-signatory firm wants to enjoin a departing employee who has left for another signatory firm from retaining information about or soliciting former clients, a court will ask whether it is likely that the departing employee breached the Protocol. Those employees who have acted in good faith are likely to be able to continue to solicit their former clients while those who have clearly exceeded the scope of the Protocol are likely to be enjoined by the court.

In one case, the representatives took a list of mutual fund ticker symbols, the names of three hedge funds and the aggregate amount of assets that their clients had invested in each one. Credit Suisse Securities (USA) LLC v. Lee, No. 11 Civ. 08566(RJH), 2011 WL 6153108 at *5 (S.D.N.Y. Dec. 9, 2011). But this did not violate the Protocol because the defendants only took a vague set of information that did not reveal any single client’s personal information, and because the limited scope of the information would not put the defendants at “any distinct competitive advantage.” Id. at *5. Also, even though there was a file containing client information on a defendant’s personal computer, the defendant acted in good faith by deleting the file upon discovering it. Id.

Courts will not tolerate those who act in bad faith or violate the letter or spirit of the Protocol. One departing employee emailed to his personal email address clients’ financial plans and other confidential information when he resigned. He sent many of those emails “in the course of three minutes, on a Friday night, approximately one week before he attempted to resign.” The court decided his actions suggested he took confidential client information and then tried to use the Protocol to avoid the terms of his other restrictive covenants. His actions went “against the terms and spirit of the Protocol.” American Financial Services, Inc. v. Koenig, Civil Action No. 11-6140-NLH-JS, 2012 WL 379940 (D.N.J. Feb 6, 2012).

2. Do not take the information regarding or attempt to solicit clients that you did not personally acquire, develop, or bring to the firm.

Courts are more likely to allow a departing broker to contact and solicit those clients that that broker earned when working at the former firm as opposed to those clients that the broker acquired via a coworker or the firm’s goodwill. For example, a financial advisor who left a team with whom he had worked and signed a restrictive covenant could not solicit any clients other team members had acquired. UBS Financial Services, Inc. v. Christenson, Civil No. 13-1081 (MJD/JSM), 2013 WL 2145703 at *4 (D. Minn. May 15, 2013). However, the advisor was still allowed to reach out to the disputed clients to inform them of his departure because “there is a difference between soliciting and contacting.” Id at *5.

3. Courts have refused to recognize the Protocol as an “industry standard”

Since the Protocol is a contract, it cannot bind a nonparty. Therefore, non-signatories can sue departing representatives who violate non-solicitation agreements. See Hilliard v. Clark, No. 1:07-cv-911, 2007 WL 2589956 at *8 (W.D. Mich. Aug. 31, 2007).

4. Firms that have signed the Protocol may fail to obtain a preliminary injunction even when the employee has transitioned to a non-Protocol firm.

Signatory firms have struggled to show that a departing employee who complies with the Protocol creates an extreme risk of irreparable harm, even when that employee has gone to a non-signatory firm. The Protocol demonstrates that financial firms implicitly accept that “brokers will leave and take client lists with them.” Merril Lynch, Pierce, Fenner & Smith, Inc. v. Brennan, No.1:07CV475, 2007 WL 632904 at *3 (N.D. Ohio, Feb. 23, 2007). Because the former firm will be in the same position as if the departing advisor had moved to another Protocol firm it will surely survive the transition. Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Baxter, No. 1:09CV45DAK, 2009 WL 960773, at *6 (D. Utah Apr. 8, 2009).

Also, a non-solicitation agreement can have a potentially devastating effect on a departing employee. Individual advisors often spend their whole careers building a client base. An injunction “barring them with any contact with their clients would effectively cripple their careers.” Id at *7.

However, it may be inequitable to allow parties that have not signed to incur the benefits of the Protocol—an incoming financial advisor being allowed to solicit his clients from his former firm—without incurring the risks of a departing financial advisor taking her clients with her. There is, in essence, no reciprocity when one signatory and one non-signatory are involved in the dispute. See Wachovia Securities, L.L.C. v. Stanton, 571 F. Supp.2d 1014, 1040 (N.D. Iowa 2008).

Though a court will not always grant a preliminary injunction when an employee leaves a Protocol firm for a non-Protocol firm, the departing advisor and the hiring firm will still likely be liable for damages to the former firm in FINRA arbitration. After all, the Protocol only governs an employee’s transitions between two signatories.

5. Compliance with the Protocol does not imply total immunity.

Courts are quick to stress that even when they do not find that it is likely a departing employee who has breached the Protocol, the Protocol only replaces non-solicitation agreements. A departing representative “could invoke the protections of the Protocol to avoid liability to his prior firm arising out of his solicitation of his former firm’s clients but nonetheless remain liable to his former employer for other wrongful conduct” such as breaching a covenant not to raid coworkers. Lee, 2011 WL 6153108 at *3.

6. Courts respect and enforce the goals of the Protocol.

The Protocol aims to further clients’ privacy interests and maximize their choices in connection with the movement of their representatives between firms. Courts consistently refer to these goals in determining whether or how to apply the Protocol in a given case.

Courts will not look fondly upon those departing brokers who take more information than permitted. The disclosure of confidential information, such as a client’s credit card and social security numbers not only violates client privacy, it also harms a firm who may lose the trust they had built with that client. As the one court explained, “[t]he fact that the Protocol does not permit disclosure of such information suggests that it is to remain highly protected.” Koenig, 2012 WL 379940 at *7.

The best way to maximize client choice is to give both the departing broker and the broker’s original firm an equal chance to solicit and win the client’s business. When both parties are on equal footing, the client can make the most informed choice possible. But if a “financial advisor one day simply disappears without warning” and cannot inform her clients of her departure because of restrictive covenants, a client’s range of choices becomes more restricted. Smith Barney Div. of Citigroup Global Markets Inc. v. Griffin, CIV.A. 08-0022-BLS1, 2008 WL 325269 at *3 (Mass. Super. Jan 23, 2008).

Thus, both employers and brokers should always make sure that their actions benefit the client first and foremost. They should not take actions that violate a client’s privacy or prevent clients from making informed decisions regarding their representation.

Employer vs. Employee: Who Owns the LinkedIn Account?

August 2nd, 2013

LinkedIn has long been considered “Facebook for the workplace” and while it is common knowledge that your Facebook page is not really private, your LinkedIn page may not really be yours. Recent court decisions have started to cast doubt about whether you own your LinkedIn account and contacts or whether your employer may have a better claim to it than the person whose name and profile picture appear at the top of the page.

LinkedIn was founded in 2003, but courts and legislatures alike have been slow to develop rules for the use of LinkedIn or other social media platforms to manage proprietary contact and client data in the professional setting. It is a common complaint by employers that their employees are stealing critical network contacts and consequently business through LinkedIn. Some of these employers have not been shy about litigating to settle the issue.

In 2008, the United Kingdom was the first to address the issue of LinkedIn contact ownership. In Hays v. Ions, the court found that an employer could require the disclosure of all of a former employee’s LinkedIn contacts from his private LinkedIn account. Because there was reason to believe Ions had used LinkedIn as a means of transcribing the company’s internal database of clients so as to be able to access it when he started his own competing firm, the court ordered the disclosure of all of Ions’ LinkedIn contacts. The obvious implication being that it was possible for the contacts to actually be proprietary information belonging to Hays, not Ions who owned the account.

In the Eastern District of New York, Sasqua Group v. Courtney addressed the same issue in 2010 but came to a very different conclusion. Here, a former employee had begun a rival firm using many of the contacts she had developed while at Sasqua. The court held that Sasqua’s client database list was not a trade secret and therefore did not “belong” to Sasqua. The rulings are facially contradictory, but the key factors relied on by the judges shine some light on how an employee or employer can protect herself. In Hays there is clear evidence of wrongdoing by Ions, e.g. collecting contact names and transferring them to LinkedIn, contacting clients to solicit business for the new firm while working at Hays, etc., such that it was easy to trace the genesis of Ions’ new clients to Hays’ database. In Sasqua the judge seemed particularly convinced by a demonstration from Courtney where she replicated part of the client list using a combination of Google, LinkedIn, and Bloomberg searches. This indicated both that there was likely no direct theft of the contacts, and that such contacts did not constitute proprietary information.

Finally, and most recently, the Eastern District of Pennsylvania ruled this Spring on a similar issue involving LinkedIn. Eagle v. Morgan was a case where an employee was terminated, and, because the employer had access to the password of the LinkedIn account, the employer changed the password and locked-out Eagle, and then proceeded to change the picture and name on the account to the new CEO while leaving some of Eagle’s honors and awards intact. In that case the contacts themselves were not held to be trade secrets because an extensive list of the company’s clients was available on their website.

More interestingly, the case raised the question of who actually owned the account. The account had been made using Eagle’s company email address and had been used specifically, although not exclusively, for company business. Eagle had even gone so far as to give the password to employees who in turn helped her manage the account. Nonetheless, Eagle was able to sustain claims that her employer used her name without authorization, invaded her privacy, and misappropriated her identity.
The court emphasized that there was no social media policy in place that established who owned the account, strongly implying that such a policy would have made a crucial difference. If an Employer considers a LinkedIn account as an extension of the company’s contacts and property, it is imperative that they establish a policy that outlines their access to the Employee’s LinkedIn account, contacts, and that such an account be relinquished to the Employer upon separation of employment.

Correspondingly, Employees should be acutely aware of any such policy and cautious about how they use their LinkedIn account, because a misstep could cost them their LinkedIn account and the critical business contacts associated with it.