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Enforcement of Non-solicitation Agreements in New York

Many employers rely on non-competition agreements to safeguard their customer relationships from being poached by former employees.  In New York, as in most states, courts carefully scrutinize non-competition agreements, mindful of the strong public policy against restraining individuals from pursuing their chosen livelihoods.  As a result of such scrutiny, courts frequently refuse to enforce non-competition agreements.  To avoid the risk that a non-competition agreement will not be enforced, employers also frequently include in their employment agreements a separate covenant prohibiting employees from soliciting the employer’s customers.  Courts view such non-solicitation agreements with greater favor, because non-solicitation agreements typically restrict the employee from soliciting only a targeted subset of customers in a particular market, and leave the employee free to work for a competitor and to solicit other customers in competition with the former employer and in the same geographic area.

The Court’s decision in Silipos, Inc. v. Bickel, 2006 WL 2265055 (S.D.N.Y. 2006) illustrates the importance of non-solicitation agreements to employers seeking to protect their customer relationships from departing employees.  The Court refused to enforce the non-competition covenant, but enforced the non-solicitation covenant.  The Court reasoned that because the departing employee did not have possession of trade secrets or confidential information, the employer did not establish “legitimate interests” justifying enforcement of the non-competition covenant throughout a geographic area that purported to be “worldwide” in scope.  By contrast, the Court found that protection of the employer’s customer base was a “legitimate interest,” but that protection of this interest justified enforcement of the non-solicitation covenant only.  In this article, we analyze the Silipos decision to illustrate the analytic differences between the enforcement of non-competition and non-solicitation covenants, and the benefit of non-solicitation agreements to employers seeking to protect their customer base from unfair competition with former employees.

Background

More than three decades ago in Reed, Roberts Associates, Inc. v. Strauman, 353 N.E.2d 590 (N.Y. 1976), the New York Court of Appeals recognized that “covenants restricting competition are enforceable only to the extent they satisfy the overriding requirement of reasonableness.”  Accordingly, the Court stated that a restrictive covenant would be enforced to the extent it was:  (1) reasonable in time and area; (2) necessary to protect the employer’s “legitimate interests”; (3) not harmful to the general public; and (4) not unreasonably burdensome to the employee.  The Court applied this rule to limit enforcement of broad restraints on competition by limiting the cognizable “legitimate interests” under the second prong to one of three interests:  (1) protection against misappropriation of trade secrets; (2) protection against misappropriation of confidential customer information; or (3) protection from competition by a former employee whose services were unique or extraordinary.  Applying these standards, the Court refused to specifically enforce a non-competition agreement against a former employee where none of these “legitimate interests” were shown to exist.

Years later, in BDO Seidman v. Hirshberg, 712 N.E.2d 1220 (1999), the New York Court of Appeals analyzed the enforceability of a restrictive covenant that required accountants to compensate the accounting firm for serving any client of one of the firm’s offices within 18 months following termination of employment.  Id. at 1222.  The Court analyzed the restrictive covenant under the same four-prong test enunciated in Reed, Roberts applicable to employee non-competition agreements.  Additionally, the Court expanded the cognizable “legitimate interests” under the second prong of the test.  Specifically, the Court recognized that an employer also has a “legitimate interest” in protecting its client base – specifically, “in preventing former employees from exploiting or appropriating the goodwill of a client or customer, which had been created and maintained at the employer’s expense, to the employer’s competitive detriment.”

The Silipos Decision

The Silipos Court applied the basic rules of Reed, Roberts and BDO Seidman in refusing to enforce a non-competition covenant, while enforcing a non-solicitation covenant.  In Silipos, a podiatric gel products manufacturer and distributor, Silipos Inc. (“Silipos”) filed an action seeking to enforce its non-competition and non-solicitation agreements with the defendant Peter Bickel (“Bickel”), the son of Silipos’s founder.  Bickel counterclaimed for a declaration that the restrictive covenants he had entered were void.  The Court consolidated a hearing on Bickel’s motion for preliminary injunction with a trial on the merits, and both parties waived trial by jury. 

The Court found that prior to his resignation from Silipos as its Executive Vice-President, Bickel had entered into an employment agreement containing the following post-employment restrictions:  (1) a non-competition agreement prohibiting Bickel from having any ownership interest or employment with anyone directly or indirectly involved in Silipos’s industry, worldwide, for one year following termination of employment (the “Non-competition Covenant”); and (2) an overlapping non-solicitation covenant prohibiting Bickel from soliciting any of Silipos’s current or prospective customers, distributors, suppliers and vendors (the “Non-solicitation Covenant”).  The Court considered the enforceability of both the Non-competition and the Non-solicitation Covenant under New York law.

The Court’s analysis recognized that both the Non-competition and Non-solicitation Covenants would be enforceable only to the extent necessary to protect Silipos’s “legitimate interests.”  Silipos asserted that its covenants were supported by three legitimate interests:  protection of trade secrets, protection of confidential customer information, and protection of its client base.  Silipos claimed that various categories of information to which Bickel had access during his employment – including marketing sales reports, strategy information and pricing information – constituted both trade secrets and confidential customer information.  The Court disagreed, however, concluding that none of the business information to which Bickel had access rose to the level of trade secrets or confidential customer information.

Next, the Court considered whether the Non-competition and Non-solicitation Covenants were necessary to protect Silipos’s client base.  Silipos argued that Bickel’s relationships with its customers were particularly significant because the podiatric gel industry was a small, interconnected industry.  Silipos had a limited customer base of 45 customers throughout the world, and these customers represented most, if not all, of the potential customers in the industry.  Thus, Silipos claimed that any competitor who employed Bickel could readily use his existing client relationships to Silipos’s detriment. 

The Court began by recognizing that protection of customer relationships is a legitimate interest when “the employee must work closely with the client or customer over a long period of time, especially when his services are a significant part of the total transaction.”  Id. at *5 (citing BDO Seidman, 712 N.E.2d at 1224).  Throughout his employment at Silipos, Bickel had varying degrees of contact with customers.  In some cases, Bickel brought the customers to Silipos, while in other cases, he was the sole or primary customer contact.  Through these relationships, Bickel negotiated discounted pricing arrangements that were central to Silipos’s business.  Based on this evidence, the Court determined that Silipos satisfied its burden of demonstrating that “Bickel’s sales activities were significant enough to establish its legitimate interest in protecting a client base.”

Non-Enforcement of the Non-competition Covenant

Based on Silipos’s lone demonstrable “legitimate interest” in protecting its client base, the Court then considered whether the Non-competition Covenant was reasonable in its temporal and geographic scope.  Recognizing that New York courts “routinely find one-year restrictions to be reasonable,” the Court found that the one-year restriction in Bickel’s Non-competition Covenant was reasonable.

The Court reached the opposite conclusion as to the worldwide geographic restriction, noting that “New York courts rarely find worldwide restrictions reasonable in any context.”  Silipos argued that the Non-competition Covenant must extend worldwide because the scope of its business is worldwide – citing to undisputed evidence that its customer base was spread throughout North America, Mexico, Europe, Australia and the Asian-Pacific countries.  The Court disagreed with Silipos, stating as follows: 

Indeed, the worldwide restriction is unreasonably broad in light of Silipos’s lone legitimate interest-protection of its client base.  To vindicate this interest, Silipos need only prevent Bickel from soliciting the particular clients for whom Bickel’s services were a significant part of the overall transaction. 

Id. at *6.  As long as Bickel did not solicit these clients, the Court found that the geographic location of a potential employer was irrelevant.

The Court also found the Non-competition Covenant to be overbroad because it precluded Bickel from engaging in a broad range of competitive activities beyond solicitation of Silipos’s clients – effectively precluding him from performing any function for any employer in the industry.  Again, the Court noted that “because Silipos’s legitimate interest extends only to protection of its client base, a covenant that forbids [Bickel] from performing any function for any employer in the industry worldwide is overbroad.”  Although the Court recognized that it had the discretion partially to enforce the Non-competition Covenant, it declined to do so.  Thus, Bickel’s Non-competition Covenant was held unenforceable in its entirety.

Partial Enforcement of the Non-solicitation Covenant

Bickel’s Non-solicitation Covenant precluded him from soliciting all of Silipos’s current or prospective customers worldwide.  In contrast to the Non-competition Covenant, the Court determined that the worldwide coverage of the Non-solicitation Covenant was not unreasonably broad.  Specifically, the Court found that “in light of the gel industry’s intimate yet geographically diffuse nature, Silipos’s legitimate interests in protecting its customer base extend worldwide.”  However, because Silipos’s legitimate interests did not extend to all of its current or prospective customers, the Court refused to enforce the Non-solicitation Covenant according to its terms.  Instead, it focused on whether partial enforcement of the Non-solicitation Covenant was appropriate under the circumstances. 

Based on BDO Seidman, the Court recognized that it had discretion to partially enforce the otherwise overbroad Non-solicitation Covenant if Silipos demonstrated good faith – i.e., “an absence of overreaching, coercive use of dominant bargaining power, or other anti-competitive misconduct.”  Key to the Court’s determination that Silipos had demonstrated good faith was 1) Bickel’s acknowledgement that he freely assented to the restrictive covenant; and 2) the fact that Bickel received a substantial annual pay raise in exchange for entering into the agreement.  Importantly, the Court also found that “Silipos did not unreasonably believe that it had or might have legitimate interests in protecting trade secrets and confidential customer information.” 

After deciding that partial enforcement of the Non-solicitation Covenant was appropriate under the circumstances, the Court enforced the covenant against Bickel only where he worked closely with that customer over a long period of time, especially where his services were a significant part of the total transaction.  Specifically, the Non-solicitation Covenant was enforceable only with respect to:  (1) customers that Bickel brought to Silipos; (2) customers for whom Bickel was the primary contact; and (3) customers with whom Bickel had a substantial degree of long-term involvement.

Lessons Learned from Silipos

The Silipos decision is a reminder to employers of the importance of including a non-solicitation covenant in their agreements with employees who deal with customers.  Non-solicitation covenants provide a firewall against competition from departing employees, in the event that a non-competition agreement is found to be unenforceable on technical or even erroneous grounds.  As the Silipos Court noted, employers seeking to enforce non-competition agreements are most likely to obtain specific enforcement when they can demonstrate that such covenants are necessary to protect trade secrets or confidential information.  However, as demonstrated by the outcome in Silipos, employers can be surprised when courts conclude, correctly or not, that information such as future marketing plans, pricing information, and profit margins are not confidential trade secrets. 

Silipos confirms that a non-solicitation covenant can be supported by legitimate interests other than the protection of trade secrets or confidential client information – specifically, the protection of an employer’s client base.  Silipos also suggests that – where protection of an employer’s client base is the only legitimate interest at issue – a court is more likely to enforce a non-solicitation agreement as opposed to a non-competition agreement. 

Silipos confirms once again that employers should constantly strive to draft their non-competition agreements and non-solicitation agreements as narrowly as is necessary to protect the employer’s legitimate interests.  Had the employer in Silipos drafted a geographic scope that was less than “worldwide,” would the Court have found its pricing data, future marketing plans and profit margins to have been legitimate interests worthy of protection? 

Silipos also illustrates the importance of an employer’s good faith in drafting and enforcement of non-competition and non-solicitation agreements.  Because of the employer’s good faith, the Silipos Court used its discretion to partially enforce the non-solicitation covenant that it otherwise found to be overbroad.  Such partial enforcement is more likely to be awarded where, for example, an employer can demonstrate that the employee freely assented to the restrictive covenant, or that the employer did not engage in any anti-competitive misconduct.

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Reprinted with permission from the December 3, 2007 edition of the New York Law Journal© 2007 ALM media Properties, LLC. All rights reserved. Further duplication without permission is prohibited.

 

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