INFORMATION AGE NON COMPETE AGREEMENTS: EMPLOYERS BEWARE
by Robert A. O'Hare Jr. and Helen L. Monaco (Fall 2000)

As the burgeoning Information Age steadily increases the American worker's job mobility, employers increasingly consider the utility and protective features of non compete agreements. Today, many more employers seek to safeguard their confidential business or proprietary information and their customer client relationships by proffering confidentiality, non-solicitation and/or non-competition agreements to their employees. Unlike traditional employment contracts, non compete agreements rarely include provisions regarding the employee's compensation, benefits or term of employment. Instead, these kinds of agreements focus on the prohibition of three general types of behavior by the employee:

1. using or revealing the employer's confidential information;

2. soliciting the employer's employees, customers, vendors or suppliers for a specified period of time after the end of employment; and

3. competing with the employer in a defined geographic territory, and also for a certain amount of time post employment.

The paragraphs below describe in general terms the New York courts' traditional approach to enforcing non compete agreements, discuss the possible watershed cases of EarthWeb and Doubleclick, and examine how non-compete agreements in the Information Age context may be enforced.

As the Second Circuit noted in Ticor Title Insurance Co. v. Cohen, 173 F.3d 63 (2d Cir. 1999), restrictive employment covenants have existed at common law since the early eighteenth century, when the Queen's Bench enforced an agreement between bakers in 1711. Moreover, the New York Court of Appeals approved reasonable restraints on trade more than a hundred years ago in Diamond Match Co. v. Roeber, 106 N.Y. 473, 482 (1887). For the most part, however, the judiciary has long approached the enforcement of non compete agreements with reluctance. Just 25 years ago, the New York Court of Appeals acknowledged that the judicial hesitance to enforce restrictive covenants grew from "powerful considerations of public policy which militate against sanctioning the loss of a man's [or woman's] livelihood." Reed, Roberts Associates, Inc. v. Strauman, 40 N.Y.2d 303, 307 (1976). As the Court of Appeals explained, "Our economy is premised on the competition engendered by the uninhibited flow of services, talent, and ideas. Therefore, no restrictions should fetter an employee's right to apply to his own best advantage the skills and knowledge acquired by the overall experience of his previous employment." Id. at 307.

The protections afforded the employee in the New York are not unfettered. In recent years, the New York courts have reevaluated the needs of those seeking to enforce covenants not-to-compete, thereby rendering lateral employment mobility an issue of increasing importance in today's dot com economy.

New York's rule governing non-compete agreements now is the "standard of reasonableness." BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 388 (1999). The courts will enforce a covenant not to compete only if:

1. it is no greater than is required for the legitimate interest of the employer;

2. it does not impose undue hardship on the employee; and

3. it is not injurious to the public.

The Court of Appeals's 1999 decision in BDO Seidman v. Hirshberg, 93 N.Y.2d at 388, established the modern New York benchmark for the enforcement of restrictive employment covenants. In BDO Seidman, an accounting firm promoted its employee to manager (one tier below a partner). As a condition to the promotion, the employee agreed, in writing, to compensate the firm one and a half times BDO Seidman's annual client fee if he provided accounting services to a former BDO Seidman client within 18 months of his departure from the firm. Id. at 384.

When the employee ultimately started his own accounting firm, almost 100 BDO Seidman clients availed themselves of his independent services. His former employer sued for the financial penalty contained in the agreement. Both the trial court and the Appellate Division held in favor of the employee, refusing to enforce the restrictive covenant and assess the damages. Id.

The Court of Appeals reversed. The court upheld the restrictive covenant to the extent that it protected against the former employee's use of client relationships which his employer had enabled him to develop though his performance of accounting services for the firm's clientele during the course of his employment. Importantly, however, clients or customers with whom a relationship developed outside the employee's assignments for his former employer were not off limits. Id. The covenant was not coercive, said the court, in part because it was imposed in connection with a position of responsibility. The result could be different if a company requires every new employee to sign a restrictive covenant. Id.

This holding is consistent with earlier Court of Appeals rulings on the same issue. Generally, preventing the disclosure or use of trade secrets or confidential customer information is universally considered a legitimate employer interest. Courts recognize that an employer possesses a legitimate interest in "safeguarding that which has made his business successful" and in "protect[ing] himself against deliberate surreptitious commercial piracy." Reed, Roberts Assocs., 40 N.Y.2d at 309. Moreover, employers possess legitimate interests in preventing the "poaching" of employees whose services are extraordinary or unique. Id. With respect to competing for clients, a former employee may not be prohibited from competing for a former employer's clients as long as the employee refrains from the use of unfair means to compete such as stealing or memorizing a customer list. However, client identities that are readily accessible through public information, almost assuredly including the Internet, are not considered trade secrets. Id. at 308.

BDO Seidman also addresses geographic restrictions, as the former employer also sought to limit its former employee from practicing in a discrete region Buffalo, New York. While the Court of Appeals did not promulgate a black letter rule establishing a trigger for such application, it appears likely that the larger the geographical prohibition on competitive practice, the less likely a court will deem the covenant enforceable. Moreover, with the globality offered by the Internet, employees in the Internet arena need to exercise great caution when entering into a non compete agreement, as the area in which they may not compete is substantially larger than first conceived.

Decided in the same year as BDO Seidman is its federal counterpart, Ticor Title Insurance Co. v. Cohen, 173 F.3d at 63 (construing New York law). There, the Second Circuit addressed a non compete clause contained in an employment agreement between a title insurance company and one of its top salesmen. In exchange for a position of substantial responsibility, for which he earned over $1.1 million in annual salary, not including reimbursements, travel and dining expenses, the employee signed an agreement not to engage in the title insurance business within the State of New York for six months after he left Ticor's employ. However, when the employee left Ticor, he immediately accepted a New York competitor's employment offer. His former employer sought to enforce the agreement and the Second Circuit agreed, upholding the restrictive covenant in its entirety. Id. at 66 67.

The court of appeals held that the defendant's personal relationships with Ticor's clients (an element which significantly contributes to the sale of title insurance, according to the court) were "special" or "unique" and consequently, although one could not say that the employee's talents were unique or special, his client relationships were. The court noted three particularly important factors in the instance before it: (i) the nature of the title insurance business depended on personal relationships; (ii) title insurance customers were so limited that maintaining clients was crucial to the business; and (iii) the agreement had been negotiated with counsel, which alleviated fears of the employee's inferior bargaining position. As a result, the court held the employee liable for breach of a reasonable restrictive covenant, even where there was no disclosure of trade secret or confidential lists. Id. at 71 72. Non Compete Agreements and the Internet

Against this backdrop is a recent New York case brought by an online publisher against a former employee, EarthWeb, Inc. v. Schlack, 71 F. Supp.2d 299, 311 (S.D.N.Y. 1999). This case may signal a new era of jurisprudence as far as covenants not to compete in the Internet industry are concerned. Citing the rapid pace of information technology ("IT") on the Internet, the district court refused to enforce a covenant not to compete which would have prevented a former vice president, formerly responsible for website content, from working for his former employer's "direct competitors" for one year. Id.

In EarthWeb, an online publisher sought to enforce a twelve-month non-compete covenant against its former employee, a senior officer who had joined one of EarthWeb's start up competitors. Although EarthWeb's covenant not to compete was limited in scope to companies which "directly compete" with EarthWeb by providing IT information or software online to IT professionals and developers, the Southern District of New York held the twelve month period was too long given the dynamic nature of the industry and its lack of geographic borders. The court reasoned that, when "measured against the IT industry in the Internet environment, a one year hiatus from the workforce is several generations, if not an eternity." Id. at 302. In reaching this conclusion, Judge William H. Pauley III cited Doubleclick, Inc. v. Henderson, 1997 WL 731413 (N.Y. Sup. N.Y. County 1997), where that court enjoined former employees from "directly competing" with their former employers anywhere in the world, but only for six months. The contract had demanded a year of worldwide non competition. The Doubleclick court held that "[g]iven the speed with which the Internet advertising industry apparently changes, the [employees]' knowledge of DoubleClick's operation will likely lose value to such a degree that the purpose of a preliminary injunction will have evaporated before the year is up." Id. at *8.

Especially important to employers seeking guidance as to how to frame their own covenants not-to-compete is the EarthWeb court's refusal to "blue pencil," or modify, the non competition agreement, as did the court in Doubleclick. Such editing has long been the preferred judicial remedy. In this case, however, the court concluded that the employment agreement, as a whole, overreached, and the court struck it down in its entirety. While the employment agreement was terminable at any time by EarthWeb and placed a restrictive covenant on the former officer, it made no provision for the payment of severance pay if EarthWeb fired him. Furthermore, EarthWeb reserved the right to modify the terms of the agreement on a quarterly basis, subject only to "notice and acknowledgment" by the former officer. The court concluded that "read collectively, the effect of these provisions is to indenture the employee to EarthWeb." Id. at 311.

Also important to the Internet employer is that the EarthWeb court held that the former employee was not "extraordinary or unique," thus diminishing the employer's interest in restricting this employee's particular services. The employee could not be likened to "musicians, professional athletes, actors and the like," id. at 313, and it was not enough to show that the employee "excels at his work or that his performance is of high value to his employer." Id. Instead, the employer must show that the employee's services are "of such a character as to make his replacement impossible or that the loss of such services would cause the employer irreparable harm." Id.

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Questions regarding this article may be directed to Robert A. O'Hare Jr., a member of the firm.

O'Hare Parnagian LLP is located at 82 Wall Street, Suite 300, New York, NY 10005-3686. The firm specializes in corporate, commercial and insurance law and general business and personal injury litigation.