New York Court of Appeals Invalidates Choice-of-Law Provision in Restrictive Covenant Case

June 12th, 2015

The enforceability of restrictive covenants depends, to some degree, on which State’s law applies to an employment agreement. Many employment contracts have a choice-of-law provision, but a recent case from New York’s highest court makes clear that the parties’ choice of law will not always be honored.

Brown & Brown v. Johnson

In Brown & Brown v. Johnson, a Florida corporation called Brown & Brown, Inc. recruited Theresa Johnson away from her post at Blue Cross/Blue Shield to work at Brown & Brown’s New York office.  On her first day of work, Brown & Brown presented Johnson with an employment contract that included a Florida choice-of-law clause as well as a non-solicitation agreement that barred Johnson from servicing any customers of Brown & Brown’s New York office for two years after her termination.  After several years, Brown & Brown terminated Johnson, prompting her to join a competitor. At the competitor, Johnson worked with former clients of Brown & Brown, and Brown & Brown sued to enforce its non-solicitation agreement.

There were two issues for the Court of Appeals. First, was the Florida choice-of-law provision valid?  Second, was the non-solicitation clause enforceable?

The Florida Choice-of-Law Clause Was Unenforceable as Contrary to Public Policy

The Court of Appeals held that enforcing the Florida choice-of-law provision would violate New York public policy because Florida’s method of assessing restrictive covenants in employment agreements is contrary to New York’s public policy in three principal ways.

First, Florida law places a far lighter burden on employers’ attempts to demonstrate that a restriction on competition is reasonable. In Florida, an employer need only make a basic case for why the agreement is necessary to protect a legitimate business interest in order to shift the burden to the former employee to prove why the agreement should not be enforced. Brown & Brown opinion at 5.  In New York, however, the initial burden is on the employer to show that the agreement protects a legitimate interest, does not harm the employee, and does not harm the general public. If the employer fails to meet any of the three requirements, then courts will not enforce the covenant.

Second, Florida courts only consider the extent to which the agreement protects the employer’s interests without any concern for hardship to the former employee. New York courts, on the other hand, weigh any damage to the former employee’s livelihood when deciding whether to enforce restrictive covenants.

Third, if the language of the agreement is ambiguous, New York courts will read it as narrowly as possible. In Florida, however, courts will read ambiguous language as broadly as is necessary to protect the legitimate interests of the employer.

In short, the court held that “Florida’s nearly-exclusive focus on the employer’s interests, prohibition against narrowly construing restrictive covenants, and refusal to consider the harm to the employee” were so contrary to New York’s emphasis on balancing the interests of the employer, employee, and general public that the former employee in this case had carried the “heavy burden” of showing that the choice-of-law clause was invalid. Brown & Brown opinion at 7.

The Non-Solicitation Clause was Overbroad, but the Court Left Partial Enforcement on the Table

The court next decided whether the non-solicitation clause was valid under New York law. It found that the clause was overbroad on its face because it purported to ban the former employee from working with any of the former employer’s customers, even those with whom the former employee had no contact.

The court further considered whether it could partially enforce the clause—i.e., give effect to the restriction only to the extent necessary to protect a legitimate employer interest.  A New York court may modify a restrictive covenant, but only if the agreement was not the result of coercion, over-reaching, or other misconduct. In Brown & Brown, the Court held that summary judgment was not appropriate on this point because fact questions remained regarding the propriety of the former employer’s conduct. In particular, the Court noted that there was conflicting evidence as to whether the former employer may have used coercive bargaining power when it asked the employee to sign the employment contract after she had resigned from her prior position.

 

 

2014-2015 Restrictive Covenant Cases of Note (NY, NJ, CT)

June 2nd, 2015

By Michael A. Naclerio and Richard M. Reice

Employers often include restrictive covenants in their employment agreements in an effort to protect investments in employees, trade secrets, and customer information. These covenants can restrict a former employee’s ability to work for competitors, prevent solicitation of past clients, and otherwise limit the former employee’s labor rights. This post surveys how courts in New York, Connecticut, and New Jersey have enforced restrictive covenants in 2014 and early 2015.

New York

In the employment context, New York courts only enforce restrictive covenants that are reasonable in duration and geographic scope, necessary to protect the employer’s legitimate interests, not harmful to the public, and not unreasonably burdensome on the employee. See BDO Seidman v. Hirshberg, 93 N.Y.2d 382 (1999).

Identifying a Legitimate Employer Interest

New York law recognizes four broad and exclusive categories of interests that justify enforcement of restrictive covenants: protecting trade secrets, preserving confidential customer information, protecting a client base, and preventing irreparable harm that would result when the departing employee is highly specialized or unique.  In 2014 and 2015, courts applying New York law further elaborated what interests fit into these broad categories.

Veramark Technologies, Inc. v. Bouk, 10 F. Supp. 3d 395 (W.D.N.Y. 2014) and Fewer v. GFI Grp. Inc., 458, 2 N.Y.S.3d 428 (N.Y. App. Div. 2015) clarified what types of employees a court would consider “unique.” In Veramark, the Western District of New York rejected the employer’s argument that Mr. Bouk was “unique” solely by virtue of his top sales rank. The court in Fewer maintained that the company could no longer argue that an employee was unique after they had demoted him from the position that employed his unique skills.

In DS Parent, Inc. v. Teich, no. 5:13-CV-1489 LEK/DEP, 2014 WL 546458 (N.D.N.Y. Feb. 10, 2014), the United States District Court for the Western District of New York clarified what interests can be valid and protectable “trade secrets.” The court determined that general knowledge of strategy only merits protection as a trade secret when it accompanies a technological trade secret or if the strategy “involve[s] detailed information about new products.” Id at *9.

Partial Enforcement When the Restriction is Unreasonably Broad

When New York courts find that a restriction is unenforceable, they may still partially enforce it by striking only the unreasonable or overbroad clauses. In the past year, courts have hesitated to use this practice, known as “blue penciling.”

In Brown & Brown, Inc. v. Johnson, 980 N.Y.S.2d 631 (4th Dep’t 2014), the court declined to partially enforce an overbroad restriction, holding that blue penciling was only appropriate where the plaintiff could demonstrate “an absence of overreaching, coercive use of bargaining power, or other anti-competitive conduct.” In this case, the court inferred coercion, because the employer offered the employment agreement containing the restrictive language only after the employee had resigned her previous job in order to work for Brown & Brown.

“No Hire” Agreements

New York Courts apply the same test to “no hire” agreements that they apply to restrictive covenants. In Reed Elsevier Inc. v. TransUnion Holding Co. Inc., No. 13 CIV. 8739 PKC, 2014 WL 97317 (S.D.N.Y. Jan. 9, 2014), the United States District Court for the Southern District of New York applied the same three-prong reasonableness standard analysis used to assess non-compete clauses to determine the enforceability of the no-hire agreement between the two companies. The court neither completely nor partially enforced the two-year term of the no-hire agreement, because Reed Elsevier Inc. could not show that the agreement protected any legitimate interest. The court also rejected Reed Elsevier Inc.’s assertion that preventing attrition of current employees could be a legitimate protectable interest.

Connecticut

Connecticut courts balance the competing needs of the parties and the public, including the employer’s desire to protect legitimate business interests, the employee’s need to find alternative employment, and public policy virtue of ensuring a competitive labor pool. See Scott v. Gen. Iron & Welding Co., 171 Conn. 132 (1976). Unlike New York, Connecticut courts have tended to favor employers in restrictive covenant disputes.

In early 2015, the Superior Court of Waterbury strictly enforced a covenant not to compete against a nail salon technician in Imperial Coast, Inc. v. Hong Nga Nguyen, 59 Conn. L. Rptr. 709 (2015). The court declined to examine whether the restraint was necessary to protect legitimate employer interests, focusing instead on the burdens to the employee. The covenant only banned competition within a ten mile radius of the plaintiff’s nail salon, a distance that the court determined did not unduly burden the former employee.

The United States District Court for the District of Connecticut enforced a two-year, 100-mile noncompetition and non-sales agreement against a former employee of a building materials distributor in A.H. Harris & Sons, Inc. v. Naso, No. 3:14CV304 AWT, 2015 WL 1420132 (D. Conn. Mar. 30, 2015). Ms. Naso had challenged both restrictions on the grounds that previous courts had deemed even weaker restrictions unreasonable. The court rejected this argument, citing evidence that the industry was especially dependent on strong relationships between suppliers and customers to suggest that the covenants were reasonable to protect the employer’s interests.

New Jersey

Like New York, New Jersey courts will only enforce reasonable restrictive covenants that protect an employer’s legitimate interests, do not impose an excessive burden on the employee, and are consistent with public policy. In 2014 and 2015 the United States District Court for the District of New Jersey made several rulings on restrictive covenant issues.

In American Financial Resources, Inc. v. Money Source, Inc., No. CIV.A. 14-1651 JLL, 2014 WL 1705617 (D.N.J. Apr. 29, 2014), the court clarified that an employer could have a legitimate business interest in information that was generally available to the public. Even though the public could readily discover American Financial Resources’ customers and mortgage rates, the previous employees had used such knowledge about specific rates offered to specific clients to gain an unfair competitive edge at their new company.

The District Court of New Jersey partially enforced a broad non-compete agreement in Interlink Group Corp. USA, Inc. v. American Trade and Financial Corp, No. CIV.A. 12–6179 JBC, 2015 WL 733469.  The court determined that a five year non-compete agreement effective anywhere in the world was unreasonable, but the judge elected to partially enforce the competition restriction as a three year ban on competing in countries in which the plaintiff operates.

Conclusion

While New York, Connecticut, and New Jersey courts did not make any radical doctrinal changes in 2014 and 2015, they did give important signals about how they will apply existing law to new cases.  Courts in New York remain hesitant to wholly or partially enforce restrictive covenants, while Connecticut and New Jersey maintained a more employer-friendly view.