BDO Seidman v. Hirshberg remains the leading New York authority on enforcing post-employment restrictive covenants — contracts that prevent an employee from competing with his employer after leaving his job, 93 N.Y.2d 382 (1999). Now approaching its 15th anniversary, BDO Seidman reiterated a principle that the Court of Appeals had stated decades earlier: a restrictive covenant is only enforceable “to the extent that it is … necessary to protect the employer’s legitimate interests,” id. at 389 (quoting Reed, Roberts Assocs. v. Strauman, 40 N.Y.2d 303, 307 ).
In litigation over a restrictive covenant, whether the old employer has a “legitimate interest” in preventing its employee from competing is a pivotal question. Unless the employer can demonstrate a legitimate interest, a court may find the covenant unenforceable as a matter of law, as the Fourth Department recently did in Brown & Brown, Inc. v. Johnson, 980 N.Y.S.2d 631, 2014 N.Y. App. Div. LEXIS 831, at *14-15 (4th Dept. Feb. 7).
To demonstrate a legitimate interest, an employer must show that a restrictive covenant is needed “to forestall unfair competition,” BDO Seidman, 93 N.Y.2d at 391 (emphasis added). In other words, an employer must prove that a former employee’s competition would cause some special harm beyond competition itself, and a restrictive covenant is needed to protect the employer from that harm.
An employer’s desire to avoid losing business to a talented former employee is not, by itself, a legitimate interest. Therefore, legitimate interests typically arise in the context of employees with special skills, knowledge or relationships with the employer’s clients, and a restrictive covenant is most likely to be enforced if it is specifically tailored to address the concerns raised by a particular employee.
BDO Seidman identified four categories of legitimate interests, which have been explored and explained in numerous state and federal court decisions.
Protection of trade secrets
An employer may prevent a former employee from competing when he possesses trade secrets that a competitor could exploit. This should not be surprising, as misappropriation of trade secrets is a classic form of unfair competition. A former employee’s dissemination of a trade secret may neutralize an employer’s competitive advantage and render the trade secret, as well as the employer’s investment in that trade secret, worthless.
The problem employers face in applying this interest is that most business information does not qualify as a trade secret. The expertise and “know how” that employees gain in the course of their work is not a trade secret. Nor is an employee’s familiarity with his former employer’s business and operations.
Knowledge of an employer’s price lists, marketing strategies, or any information that is publicly available or widely communicated to employees is not a trade secret either. An employer cannot prevent its former employee from competing simply because he learned the ins and outs of his old job. Otherwise, employers could bar most experienced employees from competing.
Instead, trade secret protection only extends to highly sensitive, valuable, and — unsurprisingly — secret information, akin to the formula for Coca-Cola. The employer must have developed the information through its own effort and expense, and have kept it closely guarded from dissemination.
Establishing trade secret status is more difficult when the information at issue is not reviewable data in the former employee’s possession, such as a confidential file, but is only the knowledge in the employee’s mind. In such cases, the employer may struggle to identify the particular information within the employee’s knowledge that qualifies as a trade secret, and is unlikely to establish trade secret status unless the employee was one of the employer’s top officers or experts.
Protection of confidential client lists
As with trade secrets, an employer has a legitimate interest in protecting its investment in identifying and analyzing clients, and in preventing competitors from misappropriating sensitive client information to gain an unfair advantage.
However, not every “list” of customers qualifies as a protectable confidential client list. Similar to the fact that an employee’s knowledge of his business is not a trade secret, an employer cannot prevent a former employee from relying on customer information that is accessible from memory.
Further, for information to constitute a confidential client list, it must be confidential. A list of clients whose identities can be obtained by reviewing public records, or are otherwise available to competitors in the same industry, is not protectable.
As a result, confidential client list protection is only available when a client list constitutes a trade secret — because it contains commercially valuable, non-public information that the employer compiled at its own effort and expense — or the former employee took or copied client data that he could not simply remember. An employer cannot wall off its customers from former employees just by compiling their names in a list.
Protection from unique or extraordinary employees
An employer may protect against competition by an employee whose skills are so special as to make him irreplaceable. “Unique or extraordinary” status is reserved for truly exceptional employees, as being of great value to an employer is not enough to render an employee unique or extraordinary. Instead, this designation is typically limited to employees providing very exclusive services, such as professional musicians, actors and athletes.
A less commonly recognized form of “unique or extraordinary” employee is one whose relationships with clients are so personal and confidential that the employee’s departure risks causing a major diversion of the employer’s business. I am not aware of any recent New York decision finding that an employee qualified as unique or extraordinary under this standard, and courts have questioned whether BDO Seidman permits restraining competition on this basis, see DS Parent, Inc. v. Teich, No. 5:13-CV-1489 (LEK/DEP), 2014 U.S. Dist. LEXIS 16116, at *37 & n.19 (N.D.N.Y. Feb. 10).
As noted in DS Parent, it is more appropriate to consider client relationships in the context of an employer’s interest in protecting its goodwill, as described below, see id.
Protection of goodwill
When an employer builds customer relationships at its expense, it can prevent former employees from “exploiting or appropriating” those relationships, BDO Seidman, 93 N.Y.2d at 392. Employees who work with customers “share in the goodwill” that the employer developed with those customers, and the employer may protect that goodwill from former employees who seek to move their client contacts to a competitor, id.
Yet BDO Seidman also recognized that an employer’s right to protect its goodwill is not absolute. Because an employer only has a legitimate interest in protecting goodwill developed at its own expense and shared with a former employee, an employer cannot restrict a former employee from soliciting clients (a) who came to the employer out of personal loyalty to the former employee, and not because of the employer’s efforts, or (b) whom the former employee never serviced while employed at his old job., see id. at 392-93.
Bans on soliciting any of an employer’s clients are unenforceable, as they impermissibly prevent a former employee from competing for these two categories of excluded clients, see Brown & Brown, 2014 N.Y. App. Div. LEXIS 831, at *14-15.
As seen in Brown & Brown, which invalidated a restrictive covenant barring solicitation of customers, courts have little sympathy for employers whose restrictive covenants venture beyond the legitimate interests identified in BDO Seidman. Employers who impose sweeping competitive restrictions on all of their employees risk having their restrictive covenants struck down. After all, employers have had almost 15 years to read BDO Seidman.
Jeremy M. Sher is an associate with the law firm of Leclair Korona Giordano Cole LLP. He concentrates his practice in the areas of commercial, securities and employment litigation. He can be reached at email@example.com or through the firm’s website at www.leclairkorona.com.