Courts Reviewing Non-Competition Clauses

RESTRICTIVE COVENANTS IN EMPLOYMENT: HOW ENFORCEABLE ARE THEY ANYWAY?

By: Harvey P. Sanders

Restrictive covenants intended to limit the ability of a worker to compete with businesses remain extremely popular.  This is true at the beginning of employment (as a condition of hire)
 during employment (as a condition of promotion), or at the end of employment (as a condition of severance pay).  Such restrictions are used, and enforced to the same degree, for employees, as well as independent contractors.  But how enforceable are they really?  Recently, the New York State Court of Appeals, the highest court in the state, weighed in on this question.  As a result, employers and employees should take a fresh look at the issue.
The Case
The case, BDO Seidman v Hirshberg, involved the Buffalo office of an accounting firm. At the time of a promotion, the firm had Hirshberg sign an agreement stating that if he took any clients of the office within eighteen (18) months after the end of his employment, he would pay the office one and a half times the firm’s billings for that client for the prior year.  It is important to note that the agreement did not prevent him from servicing these clients, it merely established the cost of doing so.  When he left to start his own practice, the firm sued–claiming that he had taken clients without paying the required compensation.  The lower level courts threw out the case, holding that the noncompetition agreement was not enforceable.  The Court of Appeals, however, found the provision could be enforceable, in part. 
 
The Legal Standard
 
The courts have adopted a three-pronged test for evaluating such agreements.  They are only enforceable if the restriction: 1.) is no greater than is required to protect the employer’s legitimate interest; 2.) does not impose undue hardship on the employee; and 3.) is not injurious to the public.  To meet the first prong, there must be a legitimate interest, such as the protection of sensitive, competitive information (like pricing, customer databases and future products) or unique and extraordinary services, that could result in unfair competition.  This protection would not be extended to information that is readily available to the public, such as through advertising, catalogues or the telephone book.  Even if there is a legitimate interest, the restriction must be reasonable as to its scope.  This is so that the interest can be protected while respecting the public policy against limiting a person’s ability to earn a living.  In evaluating the scope of a provision, courts look to the duration, geographical scope and the description of the restriction as it relates to the product or services at issue.  These factors must be looked at together on a case by case basis.  In such cases, a period of two or even five years may be upheld, while in other cases, a period of months may be considered excessive.  But how much narrower must an employer go? In some cases, a one hundred (100) mile radius around an employer’s business, or even fifty (50) miles or five (5) miles may be the maximum geographic scope, depending on duration and definition.  For example, if a prohibition is on any similar business, it may be considered too broad or a more narrow time frame and geographic scope will be required.  In the other hand, if the restriction is limited to actual customers, or even a subcategory of customers, it will be more likely to be upheld.   Finally, the court must consider any public harm.  For example, where the restriction could limit the public access to a good or service, it is less likely to be upheld.  In the present case, involving accounting services in a metropolitan area like Buffalo, this would not be a concern.  On the other hand, if the case involved a remote area, or a specialized service (like a surgical speciality), it could be very important.
Partial Enforcement
Ordinarily, courts are reluctant to rewrite a noncompetition agreement that would be otherwise unenforceable.  One reason for such a practice is to prevent employers from intentionally overreaching and counting on the courts to narrow the limitation.  In determining whether to partially enforce such a provision, courts will consider whether the overbroad provision is an essential part of the agreement and whether the employer overreached or coerced the employee.  Here, the Court of Appeals struck down that portion of the restrictive covenant relating to personal clients (those who came to the firm because of the employee’s own independent efforts, without any investment of the firms resources) and clients that the employee never directly provided substantive accounting services.  The Court did uphold that portion relating to non-personal clients for whom he provided substantive accounting services.  However, the Court did not clearly define the distinction between personal and firm clients, or the term “substantive accounting services,” leaving these to be determined by the lower courts on remand.

 
The Lesson
The enforceability of competition agreements is necessarily fact-specific, turning on the nature of the business and the specific language at issue.  Accordingly, generalizations are very difficult to make and independent legal advice is always advisable.  Parties seeking to have such agreements enforced would be well-advised to make them as narrow as possible to achieve the desired limitation.  Employees intending to compete with their former employers should avoid taking confidential information and may wish to consider having those customers following them to their new business sign a statement that the employee did not solicit their business.

Published Dec. 6, 1999