When an individual’s employment terminates and that individual goes from being a trusted employee to a competitor, numerous issues can arise regarding actions taken by that individual, prior to leaving the employer, in preparation for his or her new job. Those issues may continue and become more complicated when the individual is subject to notice/garden leave obligations and/or a non-competition agreement for some period(s) of time after his or her final day working for the employer.
A recent decision of the Circuit Court of Cook County, Ill., Chancery Division, in an action titled Citadel Investment Group, LLC v. Teza Technologies, LLC, highlights some of these post-departure issues, which apparently have not yet been explored in detail in New York case law. Familiarity with the Citadel case, and cases from other jurisdictions, discussed below, may assist the New York practitioner in addressing whether an individual’s steps taken during these restricted periods in preparation for competing with his or her former employer are permissible or not.
General Rules in New York
Many of the New York cases addressing what steps an employee may take in preparation for competing against his or her current employer, whether by seeking another position with a competing firm or by creating a competing entity, arise under claims of the employee’s breach of the duty of loyalty or fiduciary duty.
New York case law is clear that at all times prior to termination of employment, an employee owes a duty of loyalty to his or her employer. A director or officer of the employee owes an even more stringent fiduciary duty to the employer. An employee must exert his or her best efforts on behalf of the employer and not compete with it or profit at its expense, or place his or her private interests in conflict with it. American Federal Group, Ltd. v. Rothenberg, 136 F.3d 897, 905 (2d Cir. 1998).
While adhering to his or her duty of loyalty, the individual employee may take some preparatory steps toward competing, provided that those steps do not involve any dereliction of positive duties to the current employer. An employee may not, however, make use of the employer’s time, facilities or proprietary secrets in preparation for engaging in a competing business or endeavor. Scott v. Beth Israel Medical Center Inc., 47 A.D.3d 541, 850 N.Y.S.2d 81 (1st Dept. 2008).
Examples of actions that have been found by courts in New York to be merely preparatory and not in breach of duties to the current employer include:
- Incorporating a later competing business;
- Filing for and obtaining trademark registration; and
- Entering into negotiations for and purchasing a competing business.
Activities that clearly go beyond mere preparatory steps and which involve actual competition while still employed are forbidden, including the following:
- Actively soliciting customers and/or employees of the current employer to end their relationships with the current employer and go elsewhere;
- Diversion of corporate business opportunity;
- Engaging in dilatory tactics toward the end of employment to ensure that orders remain unfilled by the current employer, but then can be filled by the competitor; and
- Providing confidential information of the current employer to a competitor.
It is questionable whether an individual who plans to terminate his employment should inform his employer’s clients and/or fellow employees of his intent to resign from the employer. In some cases, such communications can be construed as solicitations of the clients or employees to join the individual at the competitor. Compare FTI Consulting Inc. v. Graves, No. 05 Civ. 6719 (NRB), 2007 WL 2192200, at *10 (SDNY July 31, 2007) (finding record did not support conclusion that defendant actively solicited client or employees) and Ecolab Inc. v. K.P. Laundry Mach. Inc., 656 F.Supp. 894, 896-97 (SDNY 1987) (holding that “goodbye notes” informing former clients that the defendants were leaving to join a competitor constituted the “first step in the solicitation” of those clients).
Types of Preparatory Steps
Are more preparatory steps allowable when an individual is within a notice or non-compete period? Bearing in mind the above discussion on permissible pre-termination preparatory steps, the general rule for post-termination competition is fairly simple. After termination of employment, in the absence of a breach of fiduciary duty, a covenant not to compete, or fraud, an employee generally is free to compete with his or her former employer. Headquarters Buick-Nissan Inc. v. Michael Oldsmobile, 149 A.D.2d 302, 303, 539 N.Y.S.2d 355 (1st Dept. 1989).
However, as more and more individuals in the work force are subject to employment agreements whereby they are required to provide substantial notice of their resignations, to sit out for some period of time on “garden leave,” and/or to refrain from competing with their employer for some time, the individuals may be limited during those restriction periods in terms of taking additional preparatory steps toward competing, even though they are no longer required to report to work for the employer.
These topics have not yet been treated extensively in New York case law, but decisions from other jurisdictions provide some guidance, and suggest that the language in the restrictive covenants will play a large role in determining what preparatory steps may be allowed.
In —ssur Holdings Inc. v. Bellacure Inc., No. C05-1552JLR, 2006 WL 2401269 (W.D. Wash. Aug. 18, 2006), —ssur was in the business of designing and manufacturing prosthetic and orthotic devices, including knee braces. The defendant employee, Shane Sterling, while employed at —ssur, was involved in the research and development of products including a knee brace.
Upon his resignation from —ssur, Sterling was subject to a post-employment one-year non-competition agreement. During that one-year period, Sterling purchased software, tools, and equipment to begin work on his own knee brace design in contemplation of competing with —ssur. He took numerous other preparatory steps during his non-compete period, including consulting with a business and finance consultant and with an attorney, contacting the same design firm that —ssur had previously hired, to discuss development of a tangible prototype, incorporating his new company, Bellacure Inc., and hiring an employee who had recently resigned from —ssur. Sterling did not launch Bellacure’s Web site until three months after the expiration of his non-compete period.
—ssur took the position that these numerous preparatory steps violated Sterling’s non-compete provision, which provided that he would not: “directly or indirectly, own, operate, provide financial, technical, or other assistance or services to, accept any involvement with, or be connected with as an officer, partner, proprietor, consultant, representative, agent or stockholder?…any organization which engages in business that is in direct competition with [—ssur].”
The court rejected —ssur’s argument, and accepted Sterling’s counterargument that the terms “engages in business?…in direct competition” were limited to actually marketing and selling a rival product. The court noted that —ssur, as the drafting party, could have written its non-competition provision to prevent Sterling from engaging in pre-market preparation, but did not, and therefore should have any ambiguity on that subject construed against it. —ssur Holdings Inc., 2006 WL 2401269 at *4.
A similar result was reached in Berardi’s Fresh Roast Inc. v. PMD Enterprises Inc., No. 90822, 2008 WL 4681825 (Ct. App. Ohio Oct. 23, 2008). That case involved a non-competition agreement described as preventing the employee from “re-entering the coffee industry for three years.” Id. at *1. Berardi’s argued that its former employee Michael Caruso violated the agreement by forming Caruso’s Coffee, hiring employees and ordering equipment and supplies prior to the expiration of the non-compete period. The court disagreed, finding that Caruso was not actively engaging in the coffee industry, but instead was “merely taking preparations so that he could commence business the day after the noncompetition agreement expired.” Id. at *5.
A different result prevailed in the recent decision in Citadel Investment Group, LLC v. Teza Technologies, LLC, slip op. (Circuit Ct. Cook County, Ill. Chan. Div. Oct. 16, 2009). The Citadel case involves two individuals who were employed in Citadel’s high frequency trading group. They resigned from Citadel in February 2009 and were subject to non-compete agreements which restricted them for nine months from becoming employees, partners, principals, or holders of certain economic interests in a “Competitive Enterprise.” “Competitive Enterprise” was defined as “any business that (i) engages in any of the investment strategies, trading strategies or any other business activities identical or similar to any of those engaged in by Citadel, or (ii) owns or controls a significant interest in any entity that engages in any of the investment strategies, trading strategies or any other business activities identical or similar to any of those engaged in by Citadel.”
After their resignations from Citadel, the two individual defendants formed a business, Teza, as a high-frequency trading company, and planned to begin trading securities in December 2009 or later. In preparation for the launch of their trading business, the defendants assembled and hired a number of employees with advanced technological and scientific backgrounds. Defendants also took actions to set up a trading platform, including by forming a quantitative research group, collecting and parsing market data, developing infrastructure such as software libraries and domain languages, developing a source code repository with restricted access, and negotiating for co-locations (i.e., to place their high frequency computer systems in close proximity to the data centers of various trading markets such as Nasdaq).
The court held that even though Teza had not begun trading, these preparatory steps constituted business activities that are identical or similar to activities conducted by Citadel’s high-frequency group, and therefore were in violation of the defendants’ non-compete agreements.
The preparatory steps in which the defendants engaged in the —ssur, Berardi’s, and Citadel cases certainly go beyond what would be permissible if those defendants had still been employed when those steps were taken. Yet the activities by the —ssur and Berardi’s defendants were held not to violate their agreements not to compete with their former employers. It may be argued then, that absent exacting restrictive language, a more generic non-compete will not prevent a former employee from taking additional and more substantial steps in preparation for competing with his or her former employer. Perhaps the reason for this is that the individual is no longer an employee, and presumably is no longer in the employer’s offices or facilities, and is without access to the employer’s confidential information, if any, and other employees. Citadel provides the example of more exacting restrictive language that can better tie the hands of the former employee during the non-compete period.
The cases discussed above do not involve preparatory steps taken during a notice or “garden leave” period, in which an individual remains an employee and is still being paid by the employer but is no longer doing work or reporting to the employer’s offices or facilities. It will be interesting to see a court evaluate the lawfulness of preparatory steps taken during a time when the employee is in such a state of limbo. On the one hand, the individual is still an employee and owes the employer his or her undivided duty of loyalty. On the other hand, the individual is not actually working for the employer or reporting to work, and therefore, theoretically should be seen as less of a disloyalty threat, and perhaps should be allowed to take more substantial steps to prepare for his or her next endeavor.
As with all cases involving restrictive covenants in the employment context, the courts’ resolutions of issues involving preparatory steps of individuals toward competition with their former employers will turn on interpretations of the particular provisions in the agreements and an analysis of the facts and circumstances presented. New York practitioners should be on the lookout for these issues in this developing area of law, and also bear them in mind if called upon to assist clients in drafting such restrictive covenants.
Reprinted with permission from the February 23, 2010, issue of The New York Law Journal. (c) 2010 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
 Schneider Leasing Plus Inc. v. Stallone, 172 A.D.2d 739, 741, 569 N.Y.S.2d 126, 128 (2d Dept. 1991).
 Abraham Zion Corp. v. Lebow, 593 F.Supp. 551, 571 (SDNY 1984).
 Tulumello v. W.J. Taylor Intern. Constr. Co. Inc., 84 A.D.2d 903, 446 N.Y.S.2d 673, 674 (4th Dept. 1981).
 Duane Jones Co. Inc. v. Burke, 306 N.Y. 172, 117 N.E.2d 237 (1954).
 Berman v. Sugo LLC, 580 F.Supp.2d 191, 206 (SDNY 2008).
 AGA Aktiebolag v. ABA Optical Corp., 441 F. Supp. 747, 754-55 (EDNY 1977).
 Scott, 850 N.Y.S.2d at 82.