The right to enforce a covenant not to compete may be lost when the employer first violates the terms of the same agreement, says a New York appeals court.
Executive Summary: The right to enforce a covenant not to compete may be lost when the employer first violates the terms of the same agreement, says a New York appeals court. In Fewer v. GFI Grp. Inc. et al., 124 A.D.3d 457, 2015 WL 176227 (First Dep't. Jan. 15, 2015), the Appellate Division covering New York County rejected GFI's attempt to enforce the covenant not to compete contained in the employment agreement of former derivatives desk president Donald Fewer because GFI breached the terms of the same agreement by demoting Fewer before he resigned. That breach also cost GFI the chance use the "employee choice" doctrine as an independent basis for enforcement of its non-compete provision. The appellate ruling also reinforces the common sense notion that an employer's prior use of restrictive covenants that are short in duration will undermine its attempt to implement subsequent restrictive covenants that run longer. Finally, the appellate ruling draws an important distinction by allowing GFI's claims for relief under employee non-solicitation provisions to proceed. Companies with employees in New York should be aware that each of these four interesting developments impacts the basic enforceability of non-compete and non-solicitation covenants going forward.
Factual Background
In 1996, Fewer began working as the head of the North American credit derivatives desk of Jersey Partners, Inc., GFI's predecessor. Under his Employment Agreement, Fewer was to handle duties performed by similarly situated employees and duties specified by JPI's president. The Employment Agreement contained a non-competition provision prohibiting Fewer from competing in the New York metropolitan area for a period of 190 business days post- termination, as well as non-solicitation clauses by which he agreed not to solicit the employment of any employee for 18 months following his employment and not to service customers with whom he worked at the company for 260 days.
In 2000, Fewer was promoted to Senior Managing Director and President, becoming responsible for the company's entire North American brokerage business and reporting directly to the CEO and president. Thereafter, he executed two option agreements containing longer non-competition provisions running for one year following the termination of his employment.
In 2007, GFI underwent a corporate realignment and replaced Fewer as the person in charge of the day-to-day operations of its North American brokerage business, limited his responsibilities to the North American credit business, and demoted him by requiring him to report to his replacement. In April 2008, Fewer gave notice that he would not extend his Employment Agreement. In September 2008, he accepted employment with Standard Credit Securities, a direct competitor of GFI.
The Lower Court's Decision
Before GFI sought to enforce its post-employment restraints, Fewer took the offensive and sued GFI for, among other things, declarations that the non-competition and non-solicitation provisions in his Employment Agreement and option agreements were unenforceable. Predictably, GFI counterclaimed, alleging, among other things, that Fewer breached his non-competition obligations. After extensive discovery, the parties cross-moved for summary judgment.
On February 21, 2014, the New York trial court held that Fewer's demotion constituted a material breach of his Employment Agreement, rendering his non-competition covenant unenforceable. The court rejected GFI's claim that Fewer's services were "unique and extraordinary" because GFI replaced him shortly after his departure. The court also held that after he was demoted Fewer no longer held the position for which the restrictive covenant provisions were intended.
The trial court also stopped GFI from using the "employee choice" doctrine to enforce the non-compete. The "employee choice" doctrine arises when an employee is faced with a choice between complying with post-employment obligations – like a non-compete covenant – or risking forfeiting certain benefits, such as option grants. Here, the lower court concluded that Fewer's shares were not a post-employment benefit to be forfeited due to his non-compliance with the covenant not to compete because he had already paid for and owned the shares.
Alternatively, the court rejected GFI's attempt to enforce the one-year restraint in Fewer's option agreements because his Employment Agreement contained a shorter covenant not to compete. The court held that GFI's shorter (190-day) restriction was proof that the longer (one year) restraint was greater than required to protect GFI's legitimate interest.
The Appellate Court's Decision
On appeal, the First Department affirmed the trial court's determination that the non-competition covenant contained in Fewer's Employment Agreement was unenforceable, holding that GFI "did not have a legitimate interest in restricting [Fewer] from working for a competitor once he was in his demoted position." 124 A.D.3d 457, 2015 WL 176227, at *1. The court, however, permitted GFI to seek enforcement of its employee non-solicitation covenant, allowing for the prospect that GFI could demonstrate a legitimate business interest in stopping Fewer from soliciting his former co-workers. In view of the employer's breach of the Employment Agreement, this marks a clear distinction between the treatment of the non-compete (unenforceable) and employee non-solicitation covenant (potentially enforceable).
Guidance for Employers
At first read, the appellate ruling suggests that any demotion defeats an employer's legitimate interest in enforcing a covenant not to compete. However, the First Department reached its conclusion based on highly specific facts of the case, namely that "[t]he significant change in [Fewer's] duties constituted a material breach of his employment agreement," that any acknowledgment with respect to the uniqueness of [Fewer's] services "was made in connection with [Fewer's] acceptance of a position he no longer held at the time of his resignation, and that "the record is devoid of evidence that plaintiff possessed any trade secrets or confidential customer lists." Id. at *1.
Employers nonetheless should recognize Fewer's key takeaways:
- An employer's prior breach of an employment contract may prevent enforcement of post-employment restraints in that same contract;
- An employer may be unable to rely upon the "employee choice" doctrine as a basis to enforce post-employment restraints if the employer is the first to breach the contract;
- An employer's prompt replacement of a departing employee undermines the assertion that the employee provided unique and extraordinary services;
- An employer may be permitted to enforce its employee non-solicitation covenant even in the absence of an enforceable covenant not to compete; and
- Where an employee is bound by two or more non-compete provisions of varying lengths, the existence of a restrictive covenant of shorter duration will undermine an attempt to enforce a longer restrictive covenant.
If you have questions regarding this decision or post-employment restrictive covenants, please feel free to contact Mark Saloman, msaloman@fordharrison.com. You may also contact the FordHarrison attorney with whom you usually work.