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Will Non-competes Be Enforced in the Internet Age?

Decisions in the New York State and Federal courts exhibit a kind of schizophrenia in the enforcement of restrictive covenants - a matter of heightened concern to employers in this high technology era. In two cases decided under New York law involving "low tech" industries, there was a seeming expansion in the scope of employer interests that will be protected by the courts. At the same time, employers were warned that if they impose restrictive covenants that are too broad, the courts may not "blue pencil" the restrictions (i.e., enforce them in limited fashion), but may simply decline to enforce the restrictions at all.

Another decision in New York, involving an employee who moved from one Internet company to another, suggests that the courts may be particularly intolerant of overbroad restrictive covenants in this dynamic segment of industry. The Court held that a one-year non-compete clause - one that was limited to companies in the same narrowly-drawn "primary business" - was "too long." Moreover, the Court declined to "blue pencil" the restriction by enforcing it for a shorter period, leaving the former employer without any immediate protective remedy.

General Observations About Restrictive Covenants

These decisions do not chart a clear roadmap for employers wishing to write bulletproof restrictive covenants. Indeed, as any review of decisions in this area over a longer period would show, considerations of equity in the particular facts and circumstances often dominate in shaping a court's thinking. Nevertheless, a few general observations can be made:

  • Employers should not assume that restrictive covenants will more readily be enforced in high tech fields than in low tech fields.
  • Employers should not assume that a "one-size-fits-all" set of restrictive covenants works best - the probability of successful enforcement can be maximized if the covenants are specially tailored for the job or employee so as to limit the scope and duration to the minimum necessary to protect the employer's legitimate interests.
  • A covenant requiring compensation based upon some reasonable formula, rather than one that prohibits competitive activity altogether, may serve as an equally successful deterrent to unfair competition by a former employee.
  • Restrictive covenants in employment contracts for a fixed period, and/or that provide for severance pay in the event of an involuntary termination, are more likely to be enforced than those in at-will agreements.
  • Restrictions that are clearly longer or broader than necessary to serve the employer's vital interests may be viewed as overreaching and be struck down altogether.
  • Employers should keep up with current trends in the enforcement of restrictive covenants in their industry and for specific types of jobs in their businesses, and should modify the covenants they use to match covenants that have been sustained in like circumstances. (See Reed Elsevier, Inc. v. TransUnion Holding Co., Inc., Dist. Court, SD New York 2014 -Court refused to uphold a "no-hire" agreement .)

Restrictive Covenant in a Title Insurance Company

In the first of the cases reviewed here, Ticor Title Insurance Co. v. Cohen, 173 F.3d 63 (2d Cir. 1999), the U.S. Court of Appeals upheld an injunction against defendant Cohen, enforcing a six-month non-compete clause in his employment agreement. Cohen was a highly paid title insurance salesman, who had exclusive responsibility for a number of key Ticor accounts. He resigned from Ticor before his carefully negotiated employment agreement had expired, and he commenced employment in the same capacity with Titleserv, one of Ticor's direct competitors.

Proceedings in the District Court were expeditious, to say the least. Ticor sued Cohen within ten days of the date he began working for Titleserv, immediately obtained a temporary restraining order, and won a permanent injunction less than thirty days later, barring Cohen from working in the title insurance business or appropriating Ticor's corporate opportunities with its current and prospective customers for a period of six months. On appeal, the Court of Appeals first addressed the question of the remedy sought - i.e., the propriety of an injunction versus monetary damages. It held that issuance of an injunction was within the District Court's discretion, because damages would be difficult to calculate for the loss of a relationship with a client that would generate an indeterminate amount of revenue in future years.

Second, the Court summarily ruled that the covenant-not-to-compete was reasonable as to duration (six months) and geographic scope (New York State), but struggled with the question of whether the services performed by Cohen were so "special" or "unique" as to warrant an injunction barring him from working in his field. After all, Cohen was just a salesman who sold a standardized product, with its terms and prices fixed by law, which was sold to a potential client base that was well known - New York law firms with real estate practices.

Curiously, the Court saw these facts as favoring Ticor! Because the product was not unique and the customer base not secret, the Court concluded that competition for business "relies more heavily on personal relationships." The Court upheld the District Court's finding that Cohen's relationships with Ticor's clients - financed by an expense allowance well in excess of $100,000 per annum - were "special" and therefore satisfied the requirement of "uniqueness" to support injunctive relief. The impact of the injunction upon Cohen himself was muted by the fact, of which the Court took note, that Titleserv had agreed to indemnify him by paying him his base salary in the event the six-month covenant-not-to-compete was enforced.

Restrictive Covenant in an Accounting Firm

In BDO Seidman v. Hirshberg, 93 N.Y.2d 382 (1999), the New York Court of Appeals held that a covenant extending for an eighteen-month period may be enforced to restrict an employee from soliciting clients of his former employer with which the employee developed relationships in the course of his work for the employer - even where the clients' identities were not a trade secret, the employee did not misuse confidential information of the employer in soliciting the business, and the employee's services to his former employer were not of a "unique or extraordinary" character. The Court also held, however, that such covenants may not be enforced to prohibit former employees from soliciting clients with whom they develop relationships other than through their own direct services on behalf of the employer.

Hirshberg became employed in 1984 by the accounting firm BDO Seidman, and was promoted to the position of manager five years later. As a condition of this promotion, Hirshberg was required to execute an at-will employment "Manager's Agreement," which provided, in part, that if he rendered services to any former client of BDO's Buffalo office within eighteen months of the termination of his employment, he would be obligated to compensate BDO "for the loss and damages suffered" by paying an amount equal to 150% of the fees that the firm had charged that client during the last year that BDO had served the client.

Hirshberg resigned from BDO in October 1993. Fifteen months later, BDO filed suit against him, alleging that he had lured away approximately 100 clients from the firm's Buffalo office, and sought compensation for this lost business. The trial court dismissed BDO's claims, concluding that the damages provision of the Manager's Agreement constituted an overbroad and unreasonable restriction on Hirshberg's post-employment activities. The Appellate Division affirmed.

In reviewing the case, the Court of Appeals first held that even though the contractual provision at issue did not directly bar Hirshberg from soliciting BDO clients, but rather obligated him to compensate the firm in the event that he did so, this provision should be evaluated under the legal standards applicable to this more traditional type of non-solicitation covenant. The Court then acknowledged that its prior decisions suggested that contractual restrictions upon post-employment activities would be enforceable only if intended to protect an employer against either (1) a former employee's misappropriation of confidential customer lists or other trade secrets, or (2) competition by a former employee whose services were of a "unique or extraordinary" nature. The Court found that neither of these criteria was satisfied. BDO did not allege that Hirshberg had misused confidential information in soliciting its clients. Moreover, in the Court's view, the services that Hirshberg had provided to BDO did not qualify as "unique or extraordinary," crediting Hirshberg's own humble opinion that, in comparison with other accountants of the firm, his accounting skills were not "unique or extraordinary."

Nonetheless, the Court partially upheld the non-solicitation covenant in Hirshberg's Agreement. In an expansion of the scope of legally protectible employer interests, the Court ruled that an employer "has a legitimate interest in preventing former employees from exploiting or appropriating the goodwill of a client or customer, which had been created and maintained at the employer's expense, to the employer's competitive detriment." Accordingly, the Court of Appeals remanded the case to the trial court, with instructions that compensation be awarded with respect to any former BDO clients served by Hirshberg after leaving the firm with which he had established relationships in the course of his work for BDO.

On the other hand, the Court declined to enforce this non-solicitation covenant as to former BDO clients with which Hirshberg had developed relationships other than through assignments in which he had performed accounting services. The Court held that BDO had no legitimate interest in requiring Hirshberg to compensate the firm for business lost to him solely as a result of Hirshberg's independent efforts.

In choosing to "blue pencil" the non-solicitation covenant, rather than invalidate it altogether, the Court emphasized that at the time that Hirshberg agreed to the covenant, BDO could reasonably have concluded from existing court precedents that Hirshberg would be deemed a "unique or extraordinary" employee, who could legitimately be precluded from soliciting any of the firm's clients, regardless of whether he developed relationships with them in the course of his services to BDO. The Court warned, however, that if an employer acts in bad faith by requiring an employee to agree to a covenant that, at the time it is entered into, is clearly invalid under existing case law, a court will likely decline to enforce the covenant at all. (See Crown It Services, Inc. v. Olsen, 11 AD 3d 263 - NY: Appellate Div., 1st Dept. 2004.)

Restrictive Covenant in an Internet Company

The case of Earthweb, Inc. v. Schlack, 71 F.Supp.2d 299 (S.D.N.Y. 1999), aff'd in part, 2000 WL 232057 (2d Cir. 2000), involved an Internet company that operated various Information Technology websites designed for an audience of IT professionals. Schlack, Earthweb's vice president responsible for website content, resigned to go to work for a print-based IT information company (IDG) that was planning to launch an Internet website four months later. Schlack's at-will employment agreement with Earthweb included both an indefinite post-employment restriction on disclosure of "Confidential Information" (which was broadly defined), and a "Limited Agreement Not to Compete." The non-compete clause prohibited Schlack, for a one-year period, from working for any entity that "directly competes" with Earthweb, limited to a website operator whose "primary business" was to provide IT professionals with a "directory of third party technology, software, and/or developer resources" and/or an on-line reference library or on-line store selling specified IT software or products.

Earthweb sued Schlack within a week of his resignation, seeking a preliminary injunction to prevent Schlack from going to work for IDG. In little more than two weeks, during which time expedited deposition and document discovery occurred, the matter was submitted for decision to the District Court. There were significant factual disputes as to the scope of Schlack's responsibility for, and knowledge of, strategic and technical information at Earthweb. Moreover, IDG's proposed website, while also targeted to IT professionals, had a somewhat different emphasis in content and was more geared for the executive level than to technicians and programmers, as was the case for Earthweb's sites.

In Conclusion

In seeking an order banning Schlack from commencing employment with IDG, Earthweb relied not only upon the non-competition covenant of the employment agreement, but also upon the "inevitable disclosure doctrine." Under this doctrine, some courts have blocked an employee who possesses highly confidential trade secrets from going to work for a direct competitor, even in the absence of a non-compete clause, based upon a contractual obligation not to use or disclose confidential information. In denying the preliminary injunction sought, the District Court first rejected out of hand Earthweb's efforts to rely upon the inevitable disclosure doctrine. In the Court's view, absent evidence of actual misappropriation of trade secrets by an employee, the doctrine should be applied only in the rarest of cases - and certainly not where the parties had expressly addressed the non-competition issue in their agreement.

The Court also ruled that it was inclined to apply a "strict construction" to the employment agreement "based on its rather onerous terms." The Court cited the facts that this was an at-will employment agreement, that there was no provision for the payment of severance in the event of an involuntary termination of employment, and that Earthweb reserved the right to modify the terms of the agreement on a quarterly basis. "Read collectively, the effect of these provisions is to indenture the employee to Earthweb." With this as its frame of reference, it is not surprising that the Court declined to grant any preliminary injunctive relief. In reaching that conclusion, the Court also opined that the one-year non-compete agreement was "too long," given the "dynamic nature" of the business, the "lack of geographic borders" on the restrictive covenant, and Schlack's former "cutting-edge position with Earthweb where his success depended upon keeping abreast of daily changes in content on the Internet." Because the Court believed that the employment agreement as a whole "overreach[ed]," it declined to "blue pencil" the non-compete covenant so as to enforce it for a shorter period.

Earthweb appealed the denial of the preliminary injunction to the Second Circuit Court of Appeals, which affirmed the lower court's decision, in an unpublished opinion and without discussion as it related to the enforcement of the non-compete provision. However, the case was remanded for further findings and consideration relating to the trade secrets and breach of confidentiality issues.

The ruling in Earthweb is surprising on several counts. One might have anticipated that an employer would have more success in enforcing a non-compete covenant where, as the Court found, the employee is in a "cutting edge position" in a "dynamic" industry. Moreover, one would not imagine that the "lack of geographic borders" would be a relevant consideration for Internet businesses that reach virtually worldwide. Finally, one-year non-competes frequently have been sustained in the past, leading one to question why the Court would not "blue pencil" the covenant to enforce it for a shorter period, rather than declining to enforce it at all. It would seem that the Court may have been influenced greatly by the fact that the covenant was part of an at-will employment agreement, as well as by the fact that, in the fast-changing "dot-com" era, being sidelined for any period of time might have severe consequences for one's career.

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