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.”

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

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.

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

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.

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

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“).

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

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.

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

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.

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

That’s exactly the question that was recently posed, or in legal terms, “certified,” to New York State’s highest court by the Federal system’s Second Circuit Court of Appeals.

In Bessemer Trust Company, N.A. v. Branin, the plaintiff sued one of its former executives in federal court for damages they allegedly sustained when he solicited his old clients from the time that he worked at their firm. According to the plaintiff, under New York’s “Mohawk Doctrine,” the defendant was prohibited from soliciting his former clients (effectively, a non-compete), because his clients and goodwill were part and parcel of his sale of the investment firm to the plaintiff.

Rejecting the defendant’s assertion that the Mohawk Doctrine was inapplicable because he “only passively assisted” his new employer in trying to pry these clients away from the plaintiff, the trial court found that he was liable to the plaintiff. On appeal, however, the Second Circuit remained troubled by the following questions, which it referred to the New York Court of Appeals:

“What degree of participation in a new employer’s solicitation of a former employer’s client by a voluntary seller of that client’s good will constitutes improper solicitation? We are particularly interested in how the following two sets of circumstances influence this analysis: (1) the active development and participation by the seller, in response to inquiries from a former client whose good will the seller has voluntarily sold to a third party, in a plan whereby others at the seller’s new company solicit the client, and (2) participation by the seller in solicitation meetings where the seller’s role is largely passive.”

The Court of Appeals’ decision on these issues will certainly be subject to a lot of debate (and probably – litigation).

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

They may have been naive, but they’re entitled to a shot at vindication before a jury, held New York’s Court of Appeals in DDJ Management LLC v. Rhone Group, LLC.

In this case, the plaintiffs sued to recover their losses after learning that the $4o million loans they extended to the defendants turned out to be based on some seriously cooked books. The defendants raised an interesting defense, which can be summarized as follows: “our books were so bad that you had no right relying on them to lend us the money.”

As noted in “Why Fraudulent Concealment Claims Are So Tough to Win,” one of the essential elements that a plaintiff must prove in order to establish a fraud claim under New York law is that she reasonably relied to her detriment upon the defendant’s representations. Applying this rule, many New York courts have dismissed fraud claims where the plaintiff’s purported reliance on the defendants’ representations was clearly unjustified, such as in Global Mins. & Metals Corp. v Holme (35 AD3d 93 [1st Dept 2006]), where the plaintiff fired an officer whom it found to be untrustworthy, and then inexplicably trusted that same officer’s verbal assurances that a transaction was completely innocent.

Importantly, New York’s High Court carved out a clear exception, and stated that one way to prove a fraudulent concealment claim under New York law is as follows:

“Where, however, a plaintiff has taken reasonable steps to protect itself against deception, it should not be denied recovery merely because hindsight suggests that it might have been possible to detect the fraud when it occurred. In particular, where a plaintiff has gone to the trouble to insist on a written representation that certain facts are true, it will often be justified in accepting that representation rather than making its own inquiry.”

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

Let there be no mistake: if you’re lying in order to stonewall your adversary, and it’s obvious to a Federal Judge, you do so at your own peril. That is the clear implication of the Court’s holding in Shcherbakovskiy v. Seitz, et al.

In that case, the defendant counterclaimed against the plaintiff, suing to recover damages they incurred in breach of contract and breach of fiduciary duty. The plaintiff, who was the chairman of the board of directors of the Russian conglomerate at issue in the case, refused to provide corporate documents notwithstanding several demands by the defendant’s attorneys, and despite a direct court order that he do so.  At first, he flatly refused on the grounds that “the demands were overly broad,” and a “fishing expedition.” Next, he claimed that the documents were immune from disclosure under Russian law. After the defendant summoned an expert on Russian law that de-bunked that theory, the plaintiff again refused on the grounds that he needed the permission of his company’s board of directors, which conveniently convened a meeting and issued a declaration barring him from disclosing the demanded documents.

Having had enough of this plaintiff’s dilatory tactics, the Judge stated as follows:

“I’m not going to allow anybody to come in here as a plaintiff and lie like that or take the position that I’m only here individually and I can’t access these Russian records because I don’t control the board, I’m only the chairman.”

And, after an appeal, sanctions against this plaintiff have now been re-affirmed; the counterclaims against them have been decided, and there is a judgment against the plaintiff in the amount of $1.78 million.

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

I’ve spoken with many people who, when confronted with the possibilities of starting their own business, hesitate – and not a small bit – because of their fear that they will forfeit their severance package from their current employer. Stated in slightly different fashion, they are concerned that any effort they expend to start a new business while they are still employed will be perceived as employee disloyalty, or, in legal terms, a breach of fiduciary duty, and thereby nullify their right to severance.

But is that fear grounded in reality?

The short answer under New York law, as you might well guess, is that it depends on whether you have a formal written severance agreement, and if so, what the agreement says. For example, in a July 1 decision in Coastal Sheet Metal Corp. v. Vassallo, New York’s Appellate Division, First Department held that the plaintiff’s former CEO had forfeited his right to his severance package because “the [trial] court’s finding that [defendant] breached his employment agreement by ‘violat[ing] the trust of his position’ negates [his] claim for severance, as a matter of law.”

Post Footer automatically generated by Add Post Footer Plugin for wordpress.