Will a New York court enforce this employee non-compete, and what happens if it is too broad?
No New York statute governing employee non-competes was found among the New York statutes available for this research; the Court of Appeals applies a common-law test, strictly, to employee restraints. The modern, prevailing standard of reasonableness for employee agreements not to compete is a three-pronged test: a restraint is reasonable only if it (1) is no greater than is required for the protection of the legitimate interest of the employer, (2) does not impose undue hardship on the employee, and (3) is not injurious to the public. A violation of any prong renders the covenant invalid, and the New York formulation the Court quotes adds the dimensions a drafter has to measure: 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”. The cognizable employer interests are limited: in Reed, Roberts Assocs. the Court confined them to protection against misappropriation of trade secrets or confidential customer lists, or protection from competition by a former employee whose services are unique or extraordinary, while giving greater weight to the employer's interest where the agreement is between professionals. In BDO Seidman it declined to treat preservation of an employer's entire client base as a legitimate interest where there was no evidence the employee gained a competitive advantage by using confidential information, and it identified the interest the firm could protect as protection against the employee's competitive use of client relationships the firm had enabled him to acquire through his performance of accounting services for its clientele; extending the covenant to clients with whom no such relationship developed violated the first prong. A footnote adds that a different result might obtain had the firm offered proof that the employee used confidential firm information to attract clients he had not served. Accountancy was held to have all the earmarks of a learned profession, but the Karpinski and Gelder Medical Group line (which enforced total restraints in limited rural locales) did not dictate the result where the employer was a national firm, the market was an entire major metropolitan area, and the employee's standing rested on his ability to attract clients rather than on unique accounting skill. Note what the restraint in that case actually was: not a bar on competing at all but a reimbursement clause, the manager agreed that if he served any former client of the firm's Buffalo office within 18 months he would compensate the firm “for the loss and damages suffered” in an amount equal to 1½ times the fees charged that client in the last full year. The Court treated that as a restrictive covenant and held it overbroad as written. An overbroad covenant is not automatically void, and that is where the case ended up: where the unenforceable portion is not an essential part of the agreed exchange, and the employer shows an absence of overreaching, coercive use of dominant bargaining power or other anti-competitive misconduct, and a good-faith effort to protect a legitimate business interest consistent with reasonable standards of fair dealing, partial enforcement may be justified. Both courts below had invalidated the whole covenant; the Court of Appeals held that was error, declared the covenant enforceable as narrowed, granted the firm partial summary judgment on liability and remitted. The remittal matters: the Court did not decide whether the 1½-times formula was a valid liquidated-damages clause or an unenforceable penalty, and sent that back for a fuller record. One sector statute does reach noncompetition covenants, and it is not an employment statute: Vehicle and Traffic Law § 466, headed “Unreasonable restrictions”, makes it unlawful for a motor-vehicle FRANCHISOR to impose “unreasonable restrictions on the franchised motor vehicle dealer relative to ... noncompetition covenants”, among other subjects. That section has only two subdivisions, and the one that says what counts as unreasonable deems unreasonable only certain franchisor conduct about the sale or transfer of a dealership; it supplies no standard for a noncompetition covenant.
The trap
Three New York-specific points decide most of these. First, the interest test excludes clients the employee brought in himself and clients the employee never served: BDO Seidman's covenant was unenforceable as to the accountant's personal clients recruited by his own independent efforts and as to firm clients with whom he never acquired a relationship through providing services during his employment, even though its time limit was a reasonably brief interlude. Second, partial enforcement is discretionary and turns on the EMPLOYER'S conduct: the covenant there was imposed in connection with a promotion, not as a condition of initial or continued employment, with no evidence of coercion, of a general plan to forestall competition, or that the firm imposed it in bad faith knowing it was overbroad, which is what supported severance. The Court of Appeals describes the requirement that an invalid portion be mechanically severable (a “judicial blue pencil”) as a now-discredited doctrine, and it rejected the lower court's reason for refusing severance, that it would have to rewrite the covenant: the time and geographic limits stayed intact and only the class of covered clients narrowed. Third, winning on severance is not winning the case. The employee defeated the covenant in Supreme Court and in the Appellate Division and still lost on appeal; and the firm, having won enforceability and liability, still had to go back to the trial court, where the 1½-times reimbursement formula may yet be struck as a penalty if the amount fixed is grossly disproportionate to the probable loss. Do not read this as a clean win for either side.
23 authorities
The words that state the rule
The modern, prevailing common-law standard of reasonableness for employee agreements not to compete applies a three-pronged test. A restraint is reasonable only if it: (1) is no greater than is required for the protection of the legitimate interest of the employer, (2) does not impose undue hardship *389 on. the employee, and (3) is not injurious to the public (see, e.g., Technical Aid Corp. v Allen, 134 NH 1, 8, 591 A2d 262, 265-266 ; Blake, op. cit., at 648-649; Restatement [Second] of Contracts § 188). A violation of any prong renders the covenant invalid. New York has adopted this prevailing standard of reasonableness in determining the validity of employee agreements not to compete. “In this context 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” (Reed, Roberts Assocs. v Strauman, 40 NY2d 303, 307 ). In general, we have strictly applied the rule to limit enforcement of broad restraints on competition.
The words that state the rule
Thus, in Reed, Roberts Assocs. (supra), we limited the cognizable employer interests under the first prong of the common-law rule to the protection against misappropriation of the employer’s trade secrets or of confidential customer lists, or protection from competition by a former employee whose services are unique or extraordinary ( 40 NY2d, at 308 ). With agreements not to compete between professionals, however, we have given greater weight to the interests of the employer in restricting competition within a confined geographical area.
The words that state the rule
Nonetheless, Gelder Medical Group and Karpinski do not dictate the result here. As we noted in Karpinski , the application of the test of reasonableness of employee restrictive covenants focuses on the particular facts and circumstances giving context to the agreement ( 28 NY2d, at 49 ; see also, Reed, Roberts Assocs. v Strauman, supra, 40 NY2d, at 307 ). This Court’s rationale for giving wider latitude to covenants between members of a learned profession because their services are unique or extraordinary (Reed, Roberts Assocs. v Strauman, supra) does not realistically apply to the actual context of the anti-competitive agreement here.
The words that state the rule
Legal scholars and courts have more circumspectly identified the employer’s legitimate interest in employee anti-competitive agreements than that of preservation of the employer’s entire client base where, as here, there is no evidence that the employee obtained a competitive advantage by using confidential information.
The words that state the rule
It follows from the foregoing that EDO’s legitimate interest here is protection against defendant’s competitive use of client relationships which EDO enabled him to acquire through his performance of accounting services for the firm’s clientele during the course of his employment (Blake, op. cit., at 647-661). Extending the anti-competitive covenant to EDO’s clients with whom a relationship with defendant did not develop through assignments to perform direct, substantive accounting services would, therefore, violate the first prong of the common-law rule: it would constitute a restraint “greater than is needed to protect” these legitimate interests (Restatement [Second] of Contracts § 188 [1] [a]).
The words that state the rule
A legitimate consideration against the exercise of this power is the fear that employers will use their superior bargaining position to impose unreasonable anti-competitive restrictions, uninhibited by the risk that a court will void the entire agreement, leaving the employee free of any restraint (id.). The prevailing, modern view rejects a per se rule that invalidates entirely any overbroad employee agreement not to compete. Instead, when, as here, the unenforceable portion is not an essential part of the agreed exchange, a court should conduct a case specific analysis, focusing on the conduct of the employer in imposing the terms of the agreement (see, Restatement [Second] of Contracts § 184). Under this approach, if the employer demonstrates an absence of overreaching, coercive use of dominant bargaining power, or other anti-competitive misconduct, but has in good faith sought to protect a legitimate business interest, consistent with reasonable standards of fair dealing, partial enforcement may be justified (see, Blake, op. cit, at 633; Restatement [Second] of Contracts § 184 [1], [2]). We essentially adopted this more flexible position in Karpinski (supra).
The words that state the rule
To the extent, then, that paragraph sixth of the Manager’s Agreement requires defendant to compensate EDO for lost patronage of clients with whom he never acquired a relationship through the direct provision of substantive accounting services during his employment, the covenant is invalid and unenforceable. By a parity of reasoning, it would be unreasonable to extend the covenant to personal clients of defendant who came to the firm solely to avail themselves of his services and only as a result of his own independent recruitment efforts, which BDO neither subsidized nor otherwise financially supported as part of a program of client development.
The words that state the rule
A different result might obtain had BDO submitted any proof that defendant had used confidential firm information to attract BDO clients with whom he had not had a relationship while employed there.
The words that state the rule
The Appellate Division’s fear that partial enforcement will require rewriting the parties’ agreement is unfounded. No additional substantive terms are required. The time and geographical limitations on the covenant remain intact. The only change is to narrow the class of BDO clients to which the covenant applies (cf.,Karpinski v Ingrasci, supra [narrowing the scope of the prohibitive post-employment activity]). Moreover, to reject partial enforcement based solely on the extent of necessary revision of the contract resembles the now-discredited doctrine that invalidation of an entire restrictive covenant is required unless the invalid portion was so divisible that it could be mechanically severed, as with a “judicial blue pencil” (see, Blake, op. cit., at 681). The Restatement (Second) of Contracts rejected that rigid requirement of strict divisibility before a covenant could be partially enforced (see, Reporter’s Note, Restatement [Second] of Contracts § 184, at 32). Thus, we conclude that severance is appropriate, rendering the restrictive covenant partially enforceable.
The words that state the rule
Here, the undisputed facts and circumstances militate in favor of partial enforcement. The covenant was not imposed as a condition of defendant’s initial employment, or even his continued employment, but in connection with promotion to a position of responsibility and trust just one step below admittance to the partnership. There is no evidence of coercion or that the Manager’s Agreement was part of some general plan to forestall competition.
The words that state the rule
Except for the overbreadth in the foregoing two respects, the restrictions in paragraph sixth do not violate the tripartite common-law test for reasonableness. The restraint on serving EDO clients is limited to 18 months, and to clients of BDO’s Buffalo office. The time constraint appears to represent a reasonably brief interlude to enable the firm to replace the client relationship and goodwill defendant was permitted to acquire with some of its clients.
- statuteN.Y. VAT Law § 466enactment date not established
The words that state the rule
§ 466. Unreasonable restrictions. 1. It shall be unlawful for a franchisor directly or indirectly to impose unreasonable restrictions on the franchised motor vehicle dealer relative to transfer, sale, right to renew or termination of a franchise, discipline, noncompetition covenants, site-control (whether by sublease, collateral pledge of lease or otherwise), right of first refusal to purchase, option to purchase, compliance with subjective standards and assertion of legal or equitable rights with respect to its franchise or dealership.
The words that state the rule
The central issue before us is whether the “reimbursement clause” in an agreement between the parties, requiring defendant to compensate BDO for serving any client of the firm’s Buffalo office within 18 months after the termination of his employment, is an invalid and unenforceable restrictive covenant. The courts below so held.
The words that state the rule
Concededly, the Manager’s Agreement defendant signed does not prevent him from competing for new clients, nor does it expressly bar him from serving BDO clients.
The words that state the rule
Nonetheless, it is not seriously disputed that the agreement, in its purpose and effect, is a form of ancillary employee anti-competitive agreement that will be carefully scrutinized by the courts (see, Columbia Ribbon & Carbon Mfg. Co. v A-1-A Corp., 42 NY2d 496, 499 ).
The words that state the rule
Close analysis of paragraph sixth of the agreement under the first prong of the common-law rule, to identify the legitimate interest of BDO and determine whether the covenant is no more restrictive than is necessary to protect that interest, leads us to conclude that the covenant as written is overbroad in some respects.
The words that state the rule
Defendant is free to compete immediately for new business in any market and, if the over-broad provisions of the covenant are struck, to retain his personal clients and those clients of EDO’s that he had not served to any significant extent while employed at the firm. He has averred that BDO’s list of lost accounts contains a number of clients in both categories. Thus, there is scant evidence suggesting that the covenant, if cured of overbreadth, would work an undue hardship on defendant. Moreover, given the likely broad array of accounting services available in the greater Buffalo area, and the limited remaining class of BDO clientele affected by the covenant, it cannot be said that the restraint, as narrowed, would seriously impinge on the availability of accounting services in the Buffalo area from which the public may draw, or cause any significant dislocation in the market or create a monopoly in accounting services in that locale. These factors militate against *394 a conclusion that a reformed paragraph sixth would violate the third prong of the common-law test, injury to the public interest (see, Gelder Med. Group v Webber, supra, 41 NY2d, at 685; Blake, op. cit., at 686-687; Restatement [Second] of Contracts § 188, comment g).
The words that state the rule
We conclude that the Appellate Division erred in holding that the entire covenant must be invalidated, and in declining partially to enforce the covenant to the extent necessary to protect BDO’s legitimate interest.
The words that state the rule
Moreover, no proof was submitted that EDO imposed the covenant in bad faith, knowing full well that it was overbroad. Indeed, as already discussed, the existence of our “learned profession” precedents, and decisions in other States upholding the full terms of this type of agreement, support the contrary conclusion. Therefore, partial enforcement of paragraph sixth is warranted.
The words that state the rule
As to those clients, the measure of plaintiffs damages will depend in the first instance on the validity of the clause in *396 paragraph sixth of the Manager’s Agreement requiring defendant to compensate BDO “for the loss and damages suffered” in an amount equal to 1½ times the fees charged each lost client over the last full year the client was served by the firm. This provision essentially represents a liquidated damages clause, as BDO conceded at nisi prius. Liquidated damages provisions, under our precedents, are valid if the “damages flowing from a breach are difficult to ascertain [and under] a provision fixing the damages in advance * * * the amount is a reasonable measure of the anticipated probable harm” (City of Rye v Public Serv. Mut. Ins. Co., 34 NY2d 470, 473 ). On the other hand, if “the amount fixed is plainly or grossly disproportionate to the probable loss, the provision calls for a penalty and will not be enforced” (Truck Rent-A-Ctr. v Puritan Farms 2nd, 41 NY2d 420, 425 ). The damages here are sufficiently difficult to ascertain to satisfy the first requirement of a valid liquidated damages provision.
The words that state the rule
In our view, however, the averment regarding the basis of the liquidated damages formula by no means conclusively *397 demonstrates the absence of gross disproportionality. Indeed, the nonspecific averment in the affidavit, quoted above, which EDO relies upon, is the only record evidence supporting the reasonableness of the liquidated damages clause.
The words that state the rule
The sparse proof on this issue here persuades us that we, similarly, should remit for further development of the record on the liquidated damages formula.
The words that state the rule
Accordingly, the order of the Appellate Division, insofar as appealed from, should be modified, without costs, by denying defendant’s motion for summary judgment, granting plaintiffs motion for partial summary judgment declaring the restrictive covenant enforceable as here provided, and remitting to Supreme Court for further proceedings in accordance with this opinion and, as so modified, affirmed.
“Defective” means that reading found something to correct. What you are reading is the rule as it stands after that reading.