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.

Posted in: Restrictive Covenants 101