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

Employment Law, Non-Compete, Restrictive Covenants

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.

JUST HOW RESTRICTIVE ARE RESTRICTIVE COVENANTS?

Employment Law, Non-Compete, Restrictive Covenants

Many employers and employees alike assume that a non-compete covenant in an employment agreement will be enforced without issue if an employee violates it. The reality, however, is far less certain. In New York, the general public policy favoring “robust and uninhibited competition” weighs “against sanctioning the loss of a man’s livelihood.” As such, New York courts will “rigorously examine” restrictive covenants and enforce them “only to the extent necessary to protect the employer from unfair competition.” If a restrictive covenant is reasonable in time and geographic scope (which is different for each case), a court will enforce a non-compete if it is necessary to protect 1) the employer’s trade secrets; 2) confidential customer information; 3) the employer’s client base; and 4) “irreparable harm” where the employee’s services are “unique or extraordinary” – such as a professional athlete or musician, or a broker, trader or salesperson who has a “unique relationship” with the employer’s clients.

Even if an employer can meet the rigorous test to demonstrate a restrictive covenant is necessary to protect it, the First Department Appellate Division (the appellate court that covers New York County and Bronx County) recently confirmed that an employer may not enforce a non-compete covenant against an employee terminated without cause. The court drew on prior cases that referred to the inherent unfairness of an employer seeking to prevent an employee from working when that employee did nothing to bring about her own discharge. The court confirmed that an employer’s “continued willingness to employ” the employee is a required part of enforcing a non-compete. New York courts simply will not prevent a laid off employee from trying to earn a living.

It is important to note, however, that a termination must be without cause to render a non-compete covenant unenforceable. A federal district court in New York recently explained that a termination for cause will not affect the enforceability of a non-compete because of the perverse incentive it would create. Specifically, the court stated that “to hold otherwise would be to permit employees to avoid reasonable non-compete agreements simply by ‘creating’ cause for their dismissal.” Lest one think that scenario far-fetched, this exact scenario played out in an earlier case where the court found that a doctor “purposely engaged in a course of conduct that was designed to induce [his employer] to fire him” with the hope of rendering the doctor’s non-compete unenforceable. Because the court found the non-compete was necessary to protect the employer from unfair competition, the non-compete was enforceable against the scheming doctor.

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.