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Advocate’s View: Express and implied non-solicitation customer covenants

Steven E. Cole

Steven E. Cole

The New York Court of Appeals’ 2011 decision in Bessemer Trust Co. NA v. Branin provided concrete guidance on the extent to which conduct could be considered “solicitation” of former customers in the context of the sale of a business. However, this precedent may not be wholly applicable to express covenants which purport to limit solicitation of customers by former employees after the termination of employment.

As discussed below, the two situations each involve application of judicially-imposed limitations on private contracts. However, the limits on customer solicitation imposed by implied covenants and allowed under express covenants are not necessarily co-extensive.

In Bessemer Trust, the plaintiff purchased the goodwill (including client relationships) of an investment management firm from Branin and seven other principals for a purchase price which totaled $75 million. Branin was initially employed by plaintiff but eventually left to join a competing firm. After leaving, Branin did not initiate contact with his former clients but he did respond to their inquiries, and provided information about his new employer to them in response to those inquires.

Further, Branin strategized with his new employer about how to approach certain former clients who had initiated contact. When some former clients left to join Branin’s new employer, plaintiff sued. Plaintiff did not allege a breach of any contractual provision, but rather the breach of the implied covenant against solicitation of client accounts that have been sold.

The core of the issue before the Court of Appeals was what happens when a customer seeks out a seller who is engaged in a new, competitive business. The Court of Appeals distinguished between a seller taking affirmative steps to directly communicate with customers, which is prohibited, and general advertising, which is permitted. The court held that the seller is not free to tout his new venture simply because a former client has fortuitously communicated with him.” However, the court held that the seller may participate in the solicitation of the customer with the new venture to a limited extent.

The seller was allowed to participate in meetings between the customer and representatives of the new business venture, provided that the seller provided factual information that did not go beyond the scope of the specific information sought. The seller is also free to convey certain information about the customer to the new employer, including in this case the customer’s investment preferences, financial goals and risk tolerance. However, the seller may not disparage the purchaser of the business, even if prompted, or even explain why the products or services of the new business are superior.

Are these same restrictions applicable to an employee who has signed an agreement restricting his ability to solicit the customers of his former employers? The first question, of course, is whether the restrictions are reasonably necessary to protect the legitimate interests of the employer and reasonably limited in time and geographic area. If not, the restrictions will be limited or possibly unenforceable. The purpose of this judicially-imposed limitation is to protect employees from the superior bargaining power of employers.

The reasonableness of the restrictions on solicitation of customers is not a consideration of the implied covenant considered by the court in Bessemer Trust. That is because the restrictions are implied, and not embodied in the parties’ contract.

In each case, common-law principles seek to protect different parties. In Bessemer Trust, the buyer must be protected from a seller recapturing the goodwill of a business by soliciting customers after sale. In the case of an express covenant, as addressed by the Court of Appeals in BDO Seidman v. Hirshberg, it is the former employee which receives the benefit of judicially-created protections.

Express non-solicitation covenants in employment agreements are held to a “stricter reasonableness standard” than express covenants contained in agreements for the purchase of a business. Presumably, this would also be true when compared to the implied non-solicitation covenants addressed in Bessemer Trust.

Prior to the Bessemer Trust decision, courts generally held that the former employee had to “initiate” the contact with customers to constitute solicitation. Merely responding to inquiries from former customers did not constitute solicitation. Is a former employee now limited to playing a “passive” role in connection with inquiries initiated by customers? Are the other restrictions identified in Bessemer Trust now applicable to express covenants restricting solicitation by former employees?

This question has yet to be answered in the courts. It is possible that the common law protection provided to sellers of goodwill by the court in Bessemer Trust will result in the erosion of protection of employees subject to restrictive covenants.

It is not at all clear that is a necessary or desired result. If the courts continue to apply the “stricter standard” of reasonableness to restrictive covenants in the employment context, then the Bessemer Trust restrictions on solicitation may remain limited to situations involving the sale of goodwill.

Steven E. Cole is a partner in the law firm of Leclair Korona Giordano Cole LLP, and concentrates his practice in the area of commercial and securities litigation.