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Sale of Business “Good Will” and Subsequent Competition with Purchaser May Subject Seller to Perpetual Restrictions on Contacting Former Customers and Clients

Posted in Restrictive Covenants

A recent Second Circuit Court of Appeals decision provides guidance regarding New York law concerning permissible and impermissible competitive conduct by the seller of a business, including its “good will,” who — without giving a non-compete covenant — thereafter goes into competition with the purchaser. The Second Circuit was aided by New York’s highest court which answered certified questions concerning the proper interpretation of the so-called “Mohawk doctrine.” The Second Circuit held that, in perpetuity, the seller may not disparage the purchaser, may not actively solicit former clients/customers but may respond truthfully to factual questions posed by them on their own initiative, may not provide the new employer with information that is proprietary to the purchaser but may assist in developing a plan to attract former clients/customers, and may attend meetings with them but must take a largely passive role. Bessemer Trust Co., N.A. v. Branin, Docket Nos. 08-2462-cv(L) and 08-2677-cv(XAP) (2d Cir., Apr. 5, 2012).

Defendant Branin sold the assets of his investment portfolio management business to Plaintiff Bessemer Trust. The assets included client accounts and “good will.” He did not give Bessemer a non-compete covenant. After the sale, Branin worked for Bessemer for a short time, but then resigned and joined competitor Stein Roe Investment Counselors. Branin made no promises to Stein Roe that his clients would follow him, but communicated his hope that 80% of the $2.3 million in revenue he had been generating for Bessemer would transfer to Stein Roe within a year. Before leaving Bessemer, Branin did not inform any of his clients of his impending move.

After Branin commenced employment with Stein Roe, he did not initiate contacts with his former clients. When they asked why he had left Bessemer, he gave mostly benign responses (for example, that Stein Roe’s method of dealing with clients is “more appropriate for my training and experience”). Bessemer sued Branin when the large Palmer family account that he had been managing for 15-20 years transferred to Stein Roe.

The Palmer family’s representative had called Branin and inquired about his reasons for leaving Bessemer. When Branin gave his standard answer, the representative requested a meeting to discuss how the account would be managed if it was moved to Stein Roe. Branin helped Stein Roe prepare by providing information about the Palmer family and the family’s investment philosophy. Branin attended the meeting between the Palmer family and Stein Roe, but took a passive role, apart from making introductions and occasionally amplifying a point. Afterwards, the Palmer family invited Branin to their home to make a specific proposal. Branin accepted the invitation and, while there, told them that Stein Roe’s fees would be the same as Bessemer’s and that the president of Stein Roe would be the number two person on the account. The Palmer family transferred their account to Stein Roethe next day.

Relying on Mohawk Maintenance Co. v. Kessler, 52 N.Y.2d 276, 283, 419 N.E.2d 324, 328 (1981) — “the vendor is not at liberty to destroy or depreciate the thing which he has sold; there is an implied covenant on the sale of ‘good will’ . . . not to solicit the customer which he has parted with; it would be a fraud on the contract to do so” — the district court held that Branin had violated New York law with regard to the Palmer account and awarded Bessemer $1.25 million. Both parties appealed. 

The federal appellate court initially concluded that under New York law, the principles set forth in Mohawk were unclear as applied to the facts of the Bessemer-Branin litigation. Accordingly, the Second Circuit certified several questions about the Mohawk doctrine to the New York Court of Appeals. Based on the answers, the federal appellate judges concluded that the district court judge erroneously focused on Branin’s intentions rather than his actions. Therefore, the district court’s judgment for Bessemer was vacated, and the case was remanded for further proceedings.

This decision teaches that the buyer of a personal services business (and other purchasers of “good will”) should insist on a covenant not to compete from the seller. Bessemer’s failure to do so has cost the company millions of dollars in lost revenue and enormous legal fees (there have already been five published opinions over the course of the litigation’s six years, and it isn’t over). Under the rules articulated by the New York Court of Appeals, some of which may be a bit naïve (is it believable that sellers of “good will” with long-standing business relationships will forego all meaningful communications with former clients/customers in perpetuity?), absent a covenant future sales of “good will” followed by the seller’s entry into competition could generate similar fact-intensive and expensive lawsuits.