DOES AN EMPLOYER’S $180 MILLION THEFT INVALIDATE AN EMPLOYEE’S NON-COMPETE?

What happens to an employee’s non-compete covenant if the employer and its top executives are convicted of assorted felonies – like stealing $180 million?  We have previously written that New York Courts will not enforce a non-compete covenant against an employee terminated without cause.  Viewed in this light, does an employer’s felony conviction, on its own, “constructively terminate” its employees and invalidate their restrictive covenants?  According to a recent New York Federal Court decision, the answer appears to be no – the restrictive covenants remain enforceable.

In Devos Ltd. v. Bradhold, 2017 WL 3447911 (E.D.N.Y. Aug. 11, 2017), plaintiff’s business involved warehousing pharmaceuticals for medical providers and, upon expiration, returning the drug products to their manufacturer for refunds.  Plaintiff would then pay most of the refunds to the providers while keeping a commission.  Earlier this year, plaintiff, its CEO and CFO were convicted of stealing more than $180 million in refunds owed to providers.  Following the convictions, the three individual defendants resigned from plaintiff and began working for a direct competitor.  Plaintiff sued the former employees and their new employer to enforce the employees’ non-compete and non-solicitation covenants and restrain the employees from competing until the lawsuit was resolved.  Defendants argued the convictions “effectively forced” defendants to resign because a substantial portion of plaintiff’s customers simply refused to do business with an entity convicted of fraud and plaintiff could no longer continue to operate.  Thus, defendants claimed, they were involuntarily terminated and New York law barred enforcement of their restrictive covenants.

At first blush, defendants appeared to have a leg to stand on.  In Morris v. Schroder Capital Mgmt. Int’l, 481 F.3d 86 (2d Cir. 2007), the United States Court of Appeals for the Second Circuit (the top appellate court for Federal Courts in New York, Connecticut and Vermont) held that an employee’s constructive termination can invalidate an otherwise enforceable restrictive covenant.  As set forth in Morris, defendants in Devos Ltd. would need to prove that plaintiff’s conviction “deliberately made working conditions so intolerable” that the individual defendants were forced to involuntarily resign.  The Devos Ltd. Court, however, rejected defendants’ argument.  The Court held that defendants offered no evidence beyond self-serving accounts that the convictions “effectively forced” the individual defendants to resign.  The Court held that plaintiff showed it was a going concern and at least 30 other employees did not believe it was “financially impossible” to continue working for plaintiff.  The Court further held that the individual defendants had been using the convictions to disparage plaintiff in attempts to poach plaintiff’s customers for the competitor defendant.  As a result, the Court granted plaintiff’s request and barred the individual defendants from working for the competitor defendant (or any other competitor) and soliciting plaintiff’s customers pending a final determination of the lawsuit.

While Devos Ltd. v. Bradhold did not set a bright line rule regarding the effect of corporate convictions on restrictive covenants, it did show that your boss’s theft of $180 million, on its own, might not create intolerable working conditions sufficient to invalidate your non-compete provision.  If you are an employer or an employee with any questions about non-competes and other types of restrictive covenants, please do not hesitate to contact us.

FRYDMAN LLC OBTAINS DISMISSAL OF ALL CLAIMS IN CONSTRUCTION DEFECTS ACTION

Frydman LLC recently won a motion for summary judgment dismissing a complaint that raised significant allegations and sought relief that could have cost our clients millions of dollars.  One Frydman LLC’s areas of practice concentration is real estate litigation, and this case involved serious allegations of construction defects and related claims.  In an eighteen page decision, the Court dismissed the claims as meritless and time barred.  The dismissal allows our client to avoid trial and removed claims that, if successful, could have led to millions of dollars of construction costs and damages.

Our clients purchased a five story townhouse in New York City and performed a stunningly beautiful gut renovation.  The demolition left little more than the front façade and floor joists and the home is now modernized and stylish.  Several years after completion of the renovation, their neighbor brought a lawsuit alleging that the work was defective, impermissibly used the party wall between the buildings and undermined the structural integrity of the adjacent building.  The claims included nuisance, trespass, property damage, construction defect and Building Code and Zoning violations.  The relief demanded would have required demolishing and rebuilding much of the home and also unspecified monetary damages.

Obtaining the complete dismissal of all claims necessitated two dispositive motions.  The first tranche of the dismissal occurred on the appeal of our pre-answer motion to dismiss the complaint, which the First Department Appellate Division granted in large part.  The appellate court rendered a written decision upholding a Statutes of Limitations defense and finding many of the claims failed to state a valid cause of action.

We then proceeded with fact discovery in which six subpoenas were served on construction professionals and others, nearly 10,000 pages of documents were exchanged and eight depositions were conducted, including of all parties and the main professionals on the project – the project architect, project engineer, inspecting engineer and general contractor’s project manager.  Frydman LLC successfully obtained an order compelling plaintiff to produce the electronic files of contemporaneous digital photographs plaintiff took of the renovation work, with crucial metadata that provided the dates the photographs were taken.  We successfully defended plaintiff’s barrage of motions – eleven in total, including two motions to the Appellate Division.  Frydman LLC also successfully obtained Court orders repeatedly sanctioning plaintiff for discovery failures and frivolous conduct in the litigation.  .

At the close of discovery, we moved for summary judgment dismissing the remaining claims.  Our motion was supported by eight affidavits, including affidavits from two expert witnesses, extensive deposition testimony and over thirty record exhibits, including the metadata from plaintiff’s own photographs.  Following extensive oral argument, the Court issued its eighteen page decision granting our motion in its entirety and dismissing the complaint with prejudice.  The Court held that we supported our motion with sufficient evidence of a lack of construction defects, a lack of infringement of plaintiff’s rights in the party wall, a lack of code violations and affirmative proof that many of the claims were also time barred.  We are very pleased to secure a total victory for our clients, allowing them piece of mind in their home and vindicating their position all along that the project was 100% compliant and of sound construction.

HOW AN ORAL AGREEMENT COST TWIN BROTHERS TWO JIMI HENDRIX GUITARS

In the middle of the 48th anniversary of the Woodstock music festival, we pause to remember legendary guitarist Jimi Hendrix – and a recent lawsuit involving a dispute over ownership of two of Jimi’s guitars.  The outcome of the suit is a reminder that when you loan out $400,000 worth of Jimi Hendrix guitars, you really should have a written agreement.

In Aleem v. Experience Hendrix, L.L.C., 16 cv 9206, 2017 WL 3105870 (S.D.N.Y. Jul. 20, 2017), plaintiffs alleged that, in Fall 1968, Jimi Hendrix gifted two guitars to the twin Aleem brothers, who occasionally performed and recorded with Hendrix.  By 1995, the Aleem brothers needed money and agreed to sell one of the guitars, valued at $200,000, at auction.  The Estate of Jimi Hendrix became aware of the potential sale and approached the Aleem brothers about allowing the Estate to display the guitars at the Rock and Roll Hall of Fame.  The parties allegedly orally agreed that in exchange for $30,000, the Aleem brothers would license both guitars to the Estate for public display and upon repayment of the $30,000, the Estate would return the guitars to plaintiffs.  In 2015, the Aleem brothers said they would repay the $30,000 and demanded the Estate return the guitars.  The Estate never responded and plaintiffs filed suit.

The Estate asked the Federal Court sitting in Manhattan to dismiss the lawsuit, arguing that the New York Uniform Commercial Code (“UCC”), which governs many commercial transactions, barred enforcement of the alleged oral agreement, regardless of whether it was a license agreement or an agreement for the sale of goods.  Under the UCC, both a license agreement for personal property worth $5,000 or more and an agreement to actually sell goods worth $500 or more require a signed writing indicating that the parties agreed to a contract.  UCC section 1-207 also requires that a license agreement state the price and define the subject matter, while UCC section 2-201 requires that a sale agreement specify the quantity of goods.  The Court agreed with the Estate and dismissed the suit, holding that plaintiffs did not allege the Estate signed a writing indicating the parties agreed to a contract.

Whatever their reasons, the Aleem brothers neglected to get a signed writing from the Estate memorializing their agreement.  Now, instead of jointly owning one Jimi Hendrix guitar and splitting the potential $200,000 proceeds from the auction of the other guitar, the Aleem brothers are left with no guitars and a brief mention of their names on a Rock and Roll Hall of Fame plaque.

If you have any questions about an oral or partially documented agreement, please do not hesitate to contact us.

HACKING EMAIL ACCOUNTS IS A BAD LITIGATION STRATEGY

It might seem obvious that hacking into your adversary’s email account and stealing email is a dangerous litigation tactic, but that has not stopped New York litigants from trying.  Unsurprisingly, New York Courts do not condone email theft and the trend appears to be towards harsher penalties, including recently striking a defendant’s answer and giving the hacked plaintiff a total victory.

In Forward v. Foschi, 27 Misc.3d 1224(A), 911 N.Y.S.2d 692 (Sup. Ct. Westchester Co. May 18, 2010), the parties were warring former business partners with a romantic past fighting over their former business.  Plaintiff secretly accessed defendant’s business and personal email accounts to forward emails to plaintiff’s attorney.  Defendant failed to safeguard her email accounts, having given plaintiff the password for a work account and leaving a personal account open on a shared work computer.  Defendant discovered plaintiff was accessing her work email, and intentionally sent phony emails to provide plaintiff with misleading information.  In a lengthy decision, the State Court excoriated plaintiff and his attorneys, but also scolded defendant for her deceptive tactics.  The Court precluded the use of the emails in the litigation, but because both parties engaged in deceitful conduct, refused to issue any further sanctions.

In Pure Power Boot Camp, Inc. v. Warrior Fitness Boot Camp, LLC, 759 F. Supp. 2d 417 (S.D.N.Y. 2010), plaintiffs sued two former employees for establishing a competing business while still employed and stealing proprietary business information.  While still employed with plaintiffs, the former employee accessed her personal email accounts and her newly created email account for the competing business from plaintiffs’ office, leaving the login credentials stored on plaintiffs’ server.  Defendants claimed that plaintiffs accessed and printed e-mails concerning the new competing business and unrelated personal issues.  The Federal Court precluded the use of the hacked emails in the litigation.  The Court also held that the plaintiffs violated the Stored Communications Act, which makes actionable (i) intentional access of an email account (ii) without authorization or in excess of authorization, and imposed a $4,000 statutory penalty comprised of a $1,000 fine for each unauthorized access of the email accounts.  The Court reserved decision on further sanctions, including payment of defendants’ legal fees, until making a determination at trial as to which of the plaintiffs stole the emails.

In Iris Mediaworks, Ltd. v. Vasisht, 2017 NY Slip Op 31145(U) (Sup. Ct. N.Y. Co. May 26, 2017), plaintiff sued defendants for using plaintiff’s trade secrets and resources to establish a competing business while trying to drive plaintiff out of business.  After retaining a computer forensics expert and conducting an investigation, including subpoenas to Google, plaintiff claimed that, around the time plaintiff commenced suit, defendant hacked plaintiff’s business email account and secretly auto-forwarded plaintiff’s emails over a 1.5 year period, specifically targeting confidential communications with plaintiff’s attorney.  The State Court, in its recent decision, held the hacking was “an egregious act” and defendant showed a “disregard for the judicial process.”  The Court granted the extraordinary relief of striking defendant’s answer to the complaint.  The sanction serves as an admission of liability by defendant, leaving only the amount of damages for trial.

USURY AND WHEN IS A LOAN A LOAN

New York, like many states, provides a usury defense against enforcement of certain loans, which stated simply means that if the interest rate is too high, the borrower can avoid repayment.  Usury applies to non-contingent loans (e.g. the lender has an absolute right to payment), and does not apply to investments where returns are based on future contingencies.  Whether the subject transaction is truly a loan and the lender’s right to repayment is truly absolute are fact-intensive issues heavily litigated in cases with usury defenses concerning sophisticated transactions.

In broad strokes, the usury defense in New York for individuals covers loans in an amount between $250,000 and $2.5 million with an interest rate equal to or greater than 16% per year.  For loans to corporate entities, usury applies to loans under $2.5 million with interest equal to or greater than 25% per year.

Transactions involving the “purchase” of future receivables can raise issues about whether the transaction is, or is not, truly a loan with an absolute right to repayment.  Around ten years ago, in Clever Ideas, Inc. v. 999 Rest. Corp., Index No. 602302/06, we sued in the Commercial Division of the New York State Court to enforce two Advanced Meal Sales Agreements by which our client advanced $235,000 to a restaurant in exchange for $363,500 of future credit card receipts.  We alleged the restaurant cut off the credit card payments, and sued for the balance due, interest and legal fees.  The restaurant raised a usury defense claiming the transaction was a loan with repayment being assured given the high level of credit card payments and a personal guaranty.  The restaurant claimed that given the expectedly short repayment time, the effective interest rate far exceeded 25%.  The Court refused to summarily grant or deny the defense, and held a trial was needed to determine the fact issues, including whether the plaintiff intended for the interest rate to exceed 25% per year.

Nearly a decade later, New York courts still grapple with usury defenses in transactions involving repayment by future business receipts.  In Colonial Funding Network, Inc. v. Epazz, Inc., No. 16 CIV. 5948 (LLS), 2017 WL 1944125 (S.D.N.Y. May 9, 2017), plaintiff alleges that, pursuant to three Merchant Cash Advance Agreements, it advanced the defendant-software company $600,000 in exchange for up to $900,000 of the software company’s future business receipts.  Plaintiff would receive approximately $5,400 per day, but at the end of each month, plaintiff would either credit or debit the software company the difference between the amount received and 15% of the software company’s total monthly receipts.

The software company raised a usury defense relying on the decision in our Clever Ideas case, claiming repayment would be short and secure, and the effective interest rate was just under 50% per year.  The Federal Court looked at the “real purpose” of the transaction and whether the transaction was “repayable absolutely.”  The Court summarily dismissed the usury defense, carefully distinguishing Clever Ideas in finding the software company failed to show that the advance was repayable absolutely.  Unlike in Clever Ideas, the amount of repayment could decrease and was conditioned on the amount of revenue the company generated (if any).  The transaction was, thus, not a loan, and the Court expressly held “[i]f the transaction is not a loan, there can be no usury, however unconscionable the contract may be.”