Restrictive Covenants in N.Y.: ‘Personal Clients’ Defense as appeared in New York Law JournalAugust 27, 2008
When a plaintiff employer sues a former employee under New York law for violating a noncompetition and/or nonsolicitation covenant, one of the more common defenses raised is that the individual employee brought his or her personal clients to the employer when the individual began working there.
As to those "personal clients," the former employee will argue that the restrictive covenant is overbroad, should not be enforced, and the individual should be free to continue dealing with them. (We will refer to this as the "personal clients defense").
Whether those clients can truly be considered "personal" to the individual is a fact-specific inquiry, usually involving when the individual began developing a customer relationship with the client and the extent to which the employer contributed to the development of the customer relationship.
It is important, therefore, for plaintiff employers, and their counsel, to be aware of and utilize various arguments, including those discussed below, to contest the personal clients defense. Recent case law has confirmed that the personal clients defense may not apply, even when the restrictive covenant appears in an employment agreement, if that agreement is connected to the sale of a business. In addition, the fact that an individual merely knew a client prior to securing employment with the plaintiff employer will not suffice to support the personal client defense if there was no established business relationship between the client and the individual. Finally, to the extent the employer can establish that it has subsidized or financially supported the continued relationship, it should be able to meet the legitimate business interest standard required for enforceability.
Personal Clients Defense, Possible Effects
The Court of Appeals explained the notion that restrictive covenants may not be enforceable as to personal clients in BDO Seidman v. Hirshberg, 93 NY2d 382, 690 NYS2d 854 (1999). The Court of Appeals noted that while, on the one hand, protection of customer relationships that the individual acquired in the course of employment may indeed be a legitimate business interest supporting enforcement of a restrictive covenant, on the other hand, it would be unreasonable to extend the covenant to personal clients of defendant who came to the firm solely to avail themselves of his services and only as a result of his own independent recruitment efforts, which BDO neither subsidized nor otherwise financially supported as part of a program of client development. Because the goodwill of those clients was not acquired through the expenditure of BDO's resources, the firm has no legitimate interest in preventing defendant from competing for their patronage. BDO Seidman, 93 NY2d at 393.
Accordingly, while BDO Seidman tends to favor protection of client goodwill created at the employer's expense, whether client goodwill developed as a result of the individual defendant's own independent efforts, rather than being generated and maintained primarily at the employer's expense, is a triable issue of fact. Kanan, Corbin, Schupak & Aronow Inc. v. FD International, Ltd., 8 Misc3d 412, 419, 797 NYS2d 883 (Sup. Ct., N.Y. County 2005); Milbrandt & Co. v. Griffin, 5 Misc2d 1011(A), 798 NYS2d 711, 2004 WL 2532292 (Sup. Ct., Westchester County Oct. 7, 2004).
Contesting the Personal Clients Defense
Sale of Business. A recent First Department decision, Weiser LLP v. Coopersmith, NYS2d, 2008 WL 2200233 (1st Dept. May 29, 2008), shows one possible way to contest the personal clients defense: if the plaintiff employer purchased a business for consideration and took on the individual employee and the business' pre-existing clients, then the personal clients defense is unlikely to be successful if the individual later resigns from the plaintiff and seeks to compete in violation of restrictive covenants, even if those covenants are contained in an employment agreement.
As described in the trial court's decision, Weiser LLP v. Coopersmith, 2007 WL 2815457 (Sup. Ct., N.Y. County July 25, 2007), the plaintiff accounting firm Weiser LLP had entered into a Merger Agreement with several partners of another firm, whereby that other firm merged into Weiser LLP. In addition to the Merger Agreement, the partners signed the 1998 Weiser Partnership Agreement, which contained a restrictive covenant. Three of those partners later resigned from Weiser LLP and sought to continue servicing the personal clients they had brought to Weiser LLP from their previous firm. The trial court accepted the personal clients defense, holding that the restrictive covenant did not apply to such clients because the client relationships originated with the prior firm; Weiser LLP did not create the client relationships; and Weiser LLP did not play any part in maintaining the client relationships other than through the individual partners' relationships with those clients.
On appeal, the First Department reversed on this issue, holding, among other things, that the personal clients defense was not available to the defendants because the restrictive covenant in the partnership agreement was ancillary to the Merger Agreement, and that Weiser LLP had a legitimate interest in enjoying the assets and goodwill it had acquired pursuant to the merger. Weiser LLP, 2008 WL 2200233.
A similar rationale was employed by a court in rejecting the personal clients defense in Johnson Controls Inc. v. A.P.T. Critical Systems Inc., 323 F.Supp.2d 525 (S.D.N.Y. 2004). In that case, Johnson Controls Inc. (JCI) bought a competitor company, American Power Technologies Inc. (APT).
One of the employees of APT, Nicholas Moon, left APT when JCI acquired it, and worked for two years in Spain. Then he returned to the United States and was hired by JCI, where he signed an employment agreement that had a one-year noncompetition provision. Mr. Moon worked for nearly two years at JCI before resigning and starting a competitive business, A.P.T. Critical Systems Inc.
JCI sued to enforce the noncompete and Mr. Moon argued that the clients he was pursuing were ones with whom he had personal client relationships from years in the industry. The Court rejected Mr. Moon's arguments, noting that most if not all of the clients that Mr. Moon claimed were personal to him were clients of JCI prior to his employment there, and also noting that to the extent Mr. Moon developed client relationships while previously employed with APT, those relationships were financed and supported by APT and JCI paid over $4 million to acquire APT's business, including the goodwill and relationships built up through APT's and its employees' efforts.
The Court further noted that when Mr. Moon returned to the United States and began his employment with JCI, it was only with JCI's support, and not through his own independent efforts, that Mr. Moon re-established relationships with those clients. Johnson Controls Inc., 323 F.Supp.2d at 535-36.
The converse result was reached in Riedman Corp. v. Gallager, 48 AD3d 1188, 852 NYS2d 510 (4th Dept. 2008), where plaintiff Riedman Corp. sued its former employee Robert Gallager for violating his employment agreement, which prohibited him from soliciting or accepting business from its customers for two years after termination of his employment. The complaint was dismissed and Mr. Gallager was permitted to continue to pursue his personal clients (and other Riedman Corp. clients) even though Riedman Corp. had paid Mr. Gallager's prior employer $250,000 to release Mr. Gallager from his prior employment agreement.
The Court noted that although Riedman Corp. had paid and entered into an agreement with Mr. Gallager's prior employer, it did not purchase specifically the goodwill, customer accounts or customer lists of either Mr. Gallager or his prior employer, and did not subsidize or otherwise financially support the goodwill that defendant created with his customers.
The Court found that Riedman Corp. had no legitimate interest in preventing Mr. Gallager from competing with it. Because the payment by Riedman Corp. was not made in connection with the sale of the prior employer's business and/or goodwill, it was of no help in avoiding the personal clients defense.
Defense Does Not Apply
When the Prior Relationship Was Not a Customer Relationship. Another way to contest the personal clients defense may be available if the personal clients were merely known to the individual, whether socially or otherwise, prior to the individual's employment and the employer-subsidized development of them as clients. Such circumstances are illustrated in Spinal Dimensions Inc. v. Chepenuk, 16 Misc3d 1121(A), 847 NYS2d 905, 2007 WL 2296503 (Sup. Ct., Albany County Aug. 9, 2007).
The court found that plaintiff Spinal Dimensions Inc. (SDI), a seller of medical devices, demonstrated a legitimate employer interest in enforcing restrictive covenants with respect to the accounts and customers upon whom two individual defendants called, sold products to, serviced, or otherwise developed professional relationships with in the course of their employment with SDI. One such defendant enjoyed pre-existing relationships with his assigned accounts through his prior employment as a surgical assistant and technologist, but these accounts were not subject to the personal client defense because they only developed into an actual business relationships through that defendant's employment with SDI.
A similar result was reached in Greystone Staffing Inc. v. Goehringer, 14 Misc3d 1209(A), 836 NYS2d 485, 2006 WL 3802202 (Sup. Ct., Nassau County Nov. 27, 2006), where an employee who left his position as an account manager at plaintiff Greystone Staffing Inc. (Greystone) was sued for breaching noncompetition and nonsolicitation provisions in his employment agreement with Greystone, and one of his defenses was that some of the clients at issue were personal clients recruited through his independent efforts.
The court found that it was as account manager at Greystone that Mr. Goehringer developed significant relationships with Greystone's clients, and enjoined him for a year from soliciting business from any of Greystone's customers with whom he dealt during his employ.
Where the employer can demonstrate that it has contributed to or subsidized the client relationship with the employee, a reasonable restriction should be enforced. This legitimate business interest can be derived from numerous sources.
Sometimes the new platform provided by the employer or its reputation in the industry can be credited to the employer's investment in establishing or maintaining the relationship. To the extent the employer has provided travel and entertainment expenses, client discounts, client or employee training, or capital investments enabling the employee to service the client, among other things, courts should be inclined to uphold the restriction, finding that a legitimate business interest does exist.
An unanswered question, but one pertinent to any personal clients defense, is: Who is the client, the employee at the client with whom the relationship is established or the client entity itself? If the individual at the client with whom your employee established the relationship has moved on, should the prior relationship defense still apply to the entity? Should it follow the individual to the new employer even though your employee had not done business with the new employer entity? These situations present grist for the mill in any analysis.
As the cases above demonstrate, there is no bright-line test for application of the personal clients defense. Each restrictive covenant must be viewed by the totality of the facts and circumstances presented. Where the employer can demonstrate a legitimate business interest in enforcing the restriction, either by demonstrating it was ancillary to the purchase of goodwill in a business or through its own subsidization of the relationship during the employee's tenure, the restrictions should be enforced. Failing such showings, courts applying the personal clients defense will likely modify or deny enforcement where the restraint is merely anticompetitive.
Peter L. Altieri is a member of Epstein Becker & Green, where he focuses on advising companies on the movement of employees and information between firms. David Clark, an associate at the firm, assisted in the preparation of this article.