Employers: Don’t Blow Your Employee’s Covenant Not to Compete!

By Loretta M. Gastwirth

Recently, the home health industry has been the Paul worked at a New York insurance brokerage firm for 33 years until his termination in 1995. He was employed pursuant to an employment contract containing a standard covenant-not-to-compete clause. Pursuant to the terms of that provision, Paul promised that for three years following his termination, he would not solicit any of the firm’s customers or work anyplace where he would be performing comparable duties. Before the three-year period expired however, Paul earned a position with another insurance brokerage firm where he was in fact engaged in the same type of work. As a result, Paul’s previous employer sued for breach of the restrictive covenant clause present in the original employment contract. To the surprise of Paul’s employer, Paul won.

The outcome of Paul’s case is surely not good news for New York employers who wish to protect their companies from competition by recently terminated employees. Whether termed a restrictive covenant, covenant-not-to-compete, or a non-competition provision, typically an employer will include this type of clause in their employee’s employment contracts which forbid the employee from obtaining employment with a competitive company. These clauses are included because terminated employees hold a wealth of valuable and confidential information such as customer lists, trade secrets, and knowledge of the inner workings of a company, all of which could be used to an employer’s disadvantage. Although, the inclusion of a restrictive covenant in an employment contract is designed to protect an employer from terminated employees who wished to capitalize on their termination by using the knowledge gained from their previous employment with a new employer, and courts would often enforce them, an employer can unwittingly undermine that enforceability.

Paul was victorious in his lawsuit brought by his previous employer because he was terminated without cause. In New York, when a restrictive covenant is present in an employment contract, the enforceability of that clause turns on whether the employee is terminated with cause or without cause. If the employee is terminated with cause, the restrictive covenant remains wholly enforceable. However, if the employee is discharged without cause, any restrictive covenant is rendered unenforceable by the employer. This rule was made law in 1979 by New York’s highest court, the New York Court of Appeals, in Post v. Merrill Lynch, et. al. The Post Court reasoned that it would be unfair to allow an employer to unilaterally destroy an employment contract while at the same time preventing an employee from engaging in his chosen livelihood. Surprisingly, New York is the only State in the country to adopt this rule in its current form.

What about situations where the employer’s termination without cause is inevitable, or even seemingly justifiable? Is Post still triggered? Recent decisions suggest that all terminations made “without cause” are treated alike under Post. Even in instances where a factory was forced to shut down, or a where a company was nearing bankruptcy and these companies had no choice but to incur layoffs, courts have held restrictive covenants to be unenforceable since terminations for these reasons did not constitute “cause.” The employee did not cause his own firing.

Post is also applicable to non-solicitation agreements, that is, a clause that forbids solicitation of company customers for several years following an employee’s termination. It has also been applied to a contract provision withholding employee benefit payments from employees who engage in competition with their employer. The contract provision, termed a “forfeiture-of-benefits” clause, can be rendered invalid when an employee is terminated without cause.

The Post decision as well as recent cases should send a clear warning to employers who want to protect their businesses. Employment agreements containing covenants not to compete must not only be carefully drafted, but if possible, the employer should terminate an employee pursuant to such an agreement only for cause.

Unfortunately, as with most areas of the law, ambiguities remain. It is still unclear whether a restrictive covenant will stand when an employee is fired without cause pursuant to an employment contract that explicitly allows for such termination. If you have any doubt as to the effectiveness and/or enforceability of your employment contract provisions, it is recommended that you seek advice from an attorney.

This blog posting is for informational and educational purposes only. It is general in nature and not person or circumstance specific. This blog posting is not intended nor should it be construed as rendering independent investment, legal or tax advice. It may but does not necessarily constitute attorney advertising.

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