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Comply or Lose: New York Affirms Enforcement of Non-Compete in Rescission Action for Employee Equity Grants

Posted in Non-Compete Enforceability, Practice & Procedure

By Marcus Mintz

A New York Supreme Court recently affirmed the viability of the “employee choice doctrine” in a rescission action involving employee equity grants.  See Lenel Systems Int’l., Inc. v. Smith, 106 A.D. 3d 1536, 966 N.Y.S.2d 618 (N.Y. App. Div. 2013).  The “employee choice doctrine” arises when an employee has a choice between complying with post-employment obligations, such as a non-compete or non-solicitation agreement, or risk forfeiting certain benefits, such as equity grants.

Generally, post-employment restrictions will be reviewed by a court for reasonableness and are disfavored as a restraint on an employee’s ability to earn a living.  When an employee is given the choice of compliance or forfeiture of benefits, however, “there is no unreasonable restraint upon an employee’s liberty to earn a living” as a matter of law.  Put simply, if an employee can choose whether or not to comply with a restrictive covenant, then there is no “unreasonable restraint” on the employee’s ability to earn a living.

The New York Supreme Court was recently asked to consider the application of the employee choice doctrine to an action for rescission of stock options granted to an ex-employee, Smith, based on his alleged breach of a non-compete provision in the stock option agreement.  While employed at plaintiff Lenel Systems International, Inc., Smith was granted stock options.  The stock option agreement required that, as a condition of the grant, Smith would not compete with Lenel while employed and for two years following his termination from employment.  Smith voluntarily terminated his employment and assumed employment with an alleged competitor. 

Lenel filed a lawsuit against Smith, alleging that he was violating the non-compete in his stock option agreement and seeking rescission of the stock options.  Smith moved for summary judgment on Lenel’s claim for rescission, arguing that the restrictive covenants in the stock option agreement were unreasonable and, therefore, unenforceable as a matter of law.  While the court acknowledged the general policy of disfavoring restrictive covenants against employees, it held that such policy did not apply to the facts in Lenel Systems because the employee had a choice between compliance and forfeiture.  In addition, the court held that when the “employee choice doctrine” applies, a restrictive covenant will be enforceable “without regard to reasonableness” provided that the employee voluntarily terminated his or her employment.

In addition to other tools an employer may use to protect its business interests, enforcing restrictive covenants contained in equity grants through actions for enforcement of express forfeiture provisions may provide an effective mechanism for retaining employees.  However, employers must be mindful that any inducements to comply with restrictive covenants must be sufficiently lucrative to ensure employee compliance.