Nearly one year ago, we wrote in general terms about how good faith is implied in New York contracts. This article, however, will focus on the underlying factors that New York’s courts will consider when applying this doctrine to non-solicitation agreements.

Fortunately, a hot-off-the-presses decision from New York State’s highest court offers some guidance – and some instructive language:

“Under New York common law, a seller has an “implied covenant” or “duty to refrain from soliciting former customers, which arises upon the sale of the ‘good will’ of an established business” (Mohawk Maintenance Co. v Kessler, 52 NY2d 276, 283 [1981]) … A seller’s “implied covenant” not to solicit his former customers is ‘a permanent one that is not subject to divestiture upon the passage of a reasonable period of time … This is so because “[t]he essence of [these types of] transaction[s] is, in effect, an attempt to transfer the loyalties of the business’ customers from the seller, who cultivated and created them, to the new proprietor” (id.) …

“Notwithstanding this “implied covenant,” a buyer assumes certain risks when he purchases an existing business and attempts to transfer the loyalties or “good will” of that business as his own. For example, the customers of the acquired business, “as a consequence of the change in ownership,” may choose to take their patronage elsewhere (id.). Indeed, “the occurrence of a certain amount of attrition is one of the risks that the purchaser must assume when he acquires an established business” (id.). Moreover, the seller of a business is free to subsequently compete with the purchaser and even “accept the trade of his former customers, provided that he does not actively solicit such trade …  [such as by] sending targeted mailings or making individualized telephone calls to his former customers informing them of his new business ventures … On the other hand … so long advertisements [are] general in nature — and not specifically aimed at the seller’s former customers — [they are] permissible under New York law.

“While the “implied covenant” places certain barriers on a seller’s conduct, it in no way prohibits a former customer or client from gathering information about that seller. In the free market, consumers of goods and services have the right to make informed choices …Thus, a seller of “good will” may answer the factual inquiries of a former client, so long as such responses do not go beyond the scope of the specific information sought …[but may not] explain, for example, why he believes his products or services are superior …

For additional information on this topic, please see “New York Court Clarifies Standard For “Improper Solicitation of Old Clients.”

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In a fascinating – and significant – April 28 decision, New York State’s highest court answered the following question:

How far can you go to help your new employer solicit your former clients under New York law?

Here are some of the salient facts in the breach of contract and breach of fiduciary duty case of Bessemer Trust Co., N.A. v. Branin:

In this case, Branin was a former executive of Brundage, who sold its assets, including its good will, to Bessemer for $75 million in August, 2000, with $50 million of the purchase price being payable up front, and the remaining $25 million being contingent on Bessemer and its principals meeting certain performance benchmarks. Branin, who was Brundage’s largest individual shareholder, received just over $9 million as his share of the sale. Branin continued to work for Brundage for just under 2 years, at which point he sought different employment.

Although Branin did not have any written non-compete agreement barring solicitation of former clients (which, given the magnitude of the asset purchase agreement is, to say the least, rather puzzling), he went out of his way not to actively solicit any of his former clients that were part of the asset purchase agreement when he finally left in June, 2002. In fact, he didn’t even tell any of those clients he was leaving; rather, when these clients contacted Branin privately, he informed them that he was pursuing work with a different firm in the field because this new firm’s operating philosophy “was more appropriate for him.”

Some clients, including his largest one, went out of their way to follow him, and left Bessemer. And this lawsuit followed.

In response to a question posed by a federal appeals court, New York State’s highest court concluded its opinion as follows:

“The issue in which the Second Circuit seeks our guidance is to what degree a seller may assist his new employer in responding to inquiries made by a former client. Since the seller of “good will,” absent a restrictive covenant, may compete with a purchaser, we conclude that certain activity within a new employer’s firm must be permissible …

“While a seller may not contact his former clients directly, he may, “in response to inquiries” made on a former client’s own initiative, answer factual questions … a seller’s “largely passive” role at [a client] meeting does not constitute improper solicitation in violation of the “implied covenant.”

To my thinking, this is a good and logical rule.

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Sometimes, uphill battles must be fought because there really isn’t a viable second option; the stakes are too high, and allowing the status quo to remain undisturbed without a fight can mean forfeiting your business. And that’s precisely what MGA Entertainment did in its prolonged fight over the proprietary intellectual property rights to the Bratz dolls. (It also appears that a central element to the case was a claim that a former Mattel employee who left to work for MGA Entertainment had breached his fiduciary duty to Mattel in bringing the Bratz concept to MGA).

As I noted nearly two years ago in  “Infingers Beware: Court Upholds $100 Million Verdict in Bratz Dolls Case,” appellate courts tend to give great deference to jury verdicts, and therefore, the likelihood of an appeals court throwing out a jury’s verdict was unlikely. But MGA really had no choice. Allowing this verdict to stand may have meant the ruination of their business.

So they fought. And, according to a news report from earlier today, not only did they get that jury’s verdict thrown out, but a second jury found in their favor, awarding MGA Entertainment $88.5 million in damages due to Mattel’s wrongful actions.

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Earlier today, it was reported that Microsoft has sued Matt Miszewski, the former General Manager of one of its sales teams, as well as his new employer, Salesforce.com, who happens to also be one of Microsoft’s direct competitors, to enforce Miszewski’s non-compete agreement, and bar him from working for a direct competitor – particularly as their VP of the Global Sector, for one year.

From the allegations set forth in the article, this case sounds like the paradigm of a case where a New York court would enforce the non-compete. Here are some of the sordid details:

• Immediately prior to leaving Microsoft, Miszewski downloaded roughly 25,000 pages of business files and 600 MB of data to his personal laptop, much of which included sensitive, confidential and proprietary information;
• In the month of his departure, Miszewski helped author a memorandum setting forth Microsoft’s business strategy for the Public Sector for the coming year of 2011. This material was compiled well after his agreement to assume a new position as Salesforce’s VP of Global Sales was, for all intents and purposes, a “done deal”; and,
• While working for Microsoft, his job duties specifically entailed working with and modifying their “Worldwide Public Sector Government Cloud Playbook,” which containing Microsoft’s confidential and proprietary sales strategy for marketing Microsoft’s cloud computing offerings. Importantly, the Playbook contained vital information regarding Microsoft’s evaluation of its competitors in this market – including Salesforce.com.

This is precisely the type of trade secret material that New York’s courts will look to protect, and the type of non-compete agreement that the New York courts will likely uphold, because to do otherwise would all but encourage trade secret theft and unfair competition.

Thus, it is not surprising that, at least for the time being, the Washington State judge assigned to this case signed Microsoft’s proposed order temporarily restraining Miszweski from working for the new company in this capacity pending a hearing on the issue.

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In a blog piece that was published in yesterday’s Wall Street Journal, it was reported that OfficeMax has sued A & P, the well-known supermarket chain, seeking a restraining order barring them from poaching key employees. Apparently, OfficeMax felt compelled to take this action after 3 of their key employees left, including their former chief operating officer and two of his subordinates.

As part of their claim, they have also charged the former COO, Sam Martin, with violating the non-compete clause of his employment agreement, with breach of contract and breach of fiduciary duty, claiming that his employment contract with OfficeMax explicitly barred him from soliciting, or poaching, employees away OfficeMax’s ranks.

There’s just one big fly in this particular ointment, however.

Since A & P has filed for bankruptcy protection, certain legal actions against A & P are prohibited, such as pursuing litigation against the bankruptcy debtor’s property. (For additional information on this, please see Bankruptcy Code Section 362).

The question is whether this particular claim would also be subject to bankruptcy protection. A & P’s argument that forcing it to defend this lawsuit would effectively deprive it of one of the chief benefits of bankruptcy protection – i.e., immunity from lawsuits – definitely has some merit.

But I don’t think that it is the better policy in cases of this nature. While I understand shielding a bankruptcy debtor from money judgments, that protection should not be without limits; it should not allow them to act deliberately and intentionally raid other companies’ leadership without consequence.

My guess is that OfficeMax will attack A & P’s response as follows: a restraining order is inherently equitable in nature -  it does not seek damages, and therefore is not the type of claim insulated from suit by the Bankruptcy Code. In addition, to the extent any damages are sought, it would appear that they are targeted at the individual defendant, Mr. Martin, rather than at A & P.

For now, we’ll just have to wait and see how this case shakes out.

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Reading the appellate court’s rendition of the facts in this breach of contract, breach of non-competition agreement and fraudulent inducement/concealment case, it is clear that the court empathized with the plaintiff, and wanted to allow the plaintiffs their day in court. The sordid details are as follows:

In GoSmile, Inc. v. Levine, the defendant founded the plaintiff corporation, which develops and sells tooth-whitening and oral hygiene products, and, he, together with his wife, were the company’s sole stockholders, directors and employees. In 2003, they sold a majority interest in the company to investors (the plaintiffs).

At that time, the defendants executed confidentiality and non-competition agreements that granted plaintiff exclusive ownership rights of all intellectual property, and prohibited defendants from using this information to compete with the company. In exchange for a cash payment, the defendants became at-will employees, directors and minority owners of plaintiff.

After the parties became embroiled in arguments over the company’s financial difficulties, the defendants were terminated, and later resolved their wrongful termination lawsuit arising therefrom via a settlement agreement with plaintiff and several other parties “which contained a broad mutual release of all claims of all kinds, whether known or unknown, that the parties ever had or now had.”

As part of the settlement agreement, plaintiff insisted upon – and defendant warranted – that he had neither breached the 2003 confidentiality and non-compete agreement in the past, and was also not in breach of those agreements at that time. That settlement agreement resulted in a payout to defendants of over $3 million, and an additional payout of $1 million over the following 4 years in exchange for the remainder of defendant’s stock in the company.

Later plaintiffs learned that defendant had, in fact, breached his fiduciary duties to the company, and used this confidential information to unfairly compete with the plaintiff. In other words, he deliberately lied about (in legalese, misrepresented) his breach of fiduciary duty and breach of the non-compete agreement to the plaintiff company in order to fraudulently induce them into entering into the settlement agreement, and pay him over $3 million.

Although the Court was required to sidestep some general rules in order to reach this result, and allow the plaintiff’s claims for breach of contract, rescission and fraudulent inducement to succeed, are you surprised that they did so?

I thought not.

(But if you’re interested in the legal nitty-gritty of why, see “How Breach of a Non-Compete Can Sustain Both Fraud & Breach of Contract Claims in NY“).

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In GoSmile, Inc. v. Levine, a decision that was handed down on December 21, New York’s Appellate Division, First Department (which covers New York and Bronx Counties) was confronted with the following question:  “whether a plaintiff is permitted to assert claims for both fraud and breach of contract, where the fraud claim is based upon allegations that defendant induced plaintiff to enter into that contract based on misrepresentations of present facts.”

The short answer: yes.

“Isn’t that kind of obvious?’, you ask. No, it isn’t.

Because there are some general rules at play in breach of contract cases in New York that would suggest the opposite conclusion:

(1) You can’t convert a breach of contract claim into a tort, such as fraud (which is an intentional tort); and,

(2) You can’t pursue a breach of contract or fraudulent misrepresentation or concealment claim if you waive those claims as part of a disclaimer or settlement agreement.

So why did the Court go the opposite way in this case?  Two reasons:

(1) “In the instant matter, plaintiff’s allegation that defendant knowingly misrepresented that he did not breach the confidentiality and non-compete provisions of the 2003 agreement is not merely an insincere promise of future performance. It was instead, a misrepresentation of then present facts that was collateral to the contract, and thus plaintiff sufficiently alleged a cause of action sounding in fraud“; and,

(2) The general release did not act as a bar to plaintiff’s fraud and breach of contract claims because plaintiff specifically sought defendant’s express warranty that he didn’t breach his non-compete agreement, and the general release stated clearly that it did not extend to claims which “[plaintiff] does not know or suspect to exist in his favor at the time of executing the release.” After reading the court’s rendition of the facts of this case (for more on this, see “When a Fiduciary Breaches a NY Non-Compete Agreement and Lies About It”), however, no one should be surprised at the outcome.

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New York’s Appellate Division, First Department’s dismissal of a wrongful termination and breach of contract claim by a securities firm’s compliance officer in a December 21 decision in Sullivan v. Harnisch is troubling. And I say that against a backdrop of a solid understanding and appreciation that most wrongful termination claims in New York are doomed.

But this case should have been different.

After all, the entire reason that this compliance officer was fired was because he did his job – questioning the propriety of some of his boss’s stock trades.

That said, here are my observations:

(1) I think that the Court got this decision right under current New York law.

(2) This case leaves little to no doubt that the law should be different.

Simply put, since both the plaintiff’s job description as well as his company’s ethics code required him to act as soon as he became aware that his boss (defendant Harnisch) had been “front-running,” i.e., selling shares of a stock that he owned before making similar sales for his clients, there should be an exception or carve-out, to protect such people from the at-will employment doctrine.

The plaintiff in this case is not without a consolation prize, however: his claims seeking to recover his equity in the company are still alive, and potentially worth nearly $30 million.

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If I had to summarize what I love about what I do it’s that it affords me the opportunity to help people who’ve been legitimately wronged, and to earn a living while doing it. And in order to help some people who contact my office, I try to come up with creative billing solutions to help clients fulfill their legal needs while controlling costs.  So, naturally, when someone tries to take advantage of my good intentions, I don’t appreciate it. Here’s one example:

Last week I received a call from a small business owner who was bilked out of several hundred thousand dollars by his partner in a glaring breach of contract and breach of fiduciary duty case. And – get this – he was able to document it. But we both agreed that it was not only possible, but likely, that the money he invested would be difficult to recover for a myriad of reasons.

Recognizing that this gentleman was leery of throwing out good money after bad, I proposed that he enter into a hybrid retainer agreement (as opposed to a straight hourly retainer) – whereby the legal fees he would have to pay on the entire litigation would be capped at a small fraction of the overall anticipated cost of the litigation, in exchange for the attorney collecting a 20% contingent fee in the event of a recovery.

Sounds fair, doesn’t it?

But this man – whom I’ve never met in person – was not only unwilling to fund the limited legal fees that were requested, he wanted the contingent fee to be limited to 5% of any recovery. He wanted to bear none of the risk, but to reap all the rewards, or as the old joke goes, heads he wins, tails I lose.

Here was my gut reaction: if you could actually get an attorney to agree to those terms, do you really want that attorney to be the one litigating your six-figure breach of fiduciary duty case?

It would have been far more honest of this man to ask if I could represent him pro bono.

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While it is true that, generally speaking, you can’t recover in fraud or negligence against someone unless you actually have an agreement with them (or in legal terms, are “in privity”), there is a narrow – but important – exception to this rule.

And that is when the relationship is close enough that they’re no longer at arms’ length, or as the Appellate Court in its October 26 opinion in Seaview Mezzanine Fund, LP v. Ramson put it, “approaching privity.”

In Seaview, the Plaintiff, a funding corporation, extended a capital loan to the defendant corporation based, in large part, on the defendant’s accountants’ representations (which turned out to be misrepresentations) about the defendant’s economic situation. After the defendant defaulted, the plaintiff learned that the accountants willfully exaggerated the defendant’s net worth and financial condition, notwithstanding that they knew that the plaintiff intended to rely upon this information in deciding whether to extend the loan to their client (the defendant).

In denying the accountants’ motion to dismiss the claims against them, the Court stated, in pertinent part, as follows:

“[W]e agree with the motion court that plaintiff has alleged the existence of a relationship sufficiently approaching privity so as to allow plaintiff to assert claims against the [accountants] in the absence of a direct contractual relationship … Plaintiff also properly pled  … the causes of action for fraud … alleging that the [accountants] knowingly made false representations regarding the [defendant's] finances … including exaggerating their net worth and financial condition by underreporting a certain loan, failing to disclose the existence of another loan and misrepresenting the status of an arbitration proceeding.”

At this point, something should be made clear: this decision is only Round 1; it does not, by any means, suggest that the plaintiff has won this case.

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