March 23, 2009
We live in a world where global markets are falling all around us; where competition is keener than ever, and where a company’s confidential business information, or "trade secrets," may provide it with its only critical edge over competitors. As a result, it is more important than ever to protect such intellectual property. That’s why employers frequently require their employees to sign agreements containing restrictive covenants that prohibit them from leaving to go to work for a competitor, from soliciting the employer’s customers, and from stealing the company’s trade secrets. And that’s why restrictive covenant litigation appears to be on the rise.
Unfortunately, however, restrictive covenants – whether styled as covenants not to compete, more limited non-solicitation agreements,1 confidentiality agreements or a combination of the three – are heavily disfavored under New York law. This stems from New York’s strong public policy favoring an individual’s ability to earn a livelihood. See, e.g., Columbia Ribbon & Mfg. Co. v. A-1-A Corp., 42 NY2d 496, 499, 398 NYS2d 1004, 1006 (1977); Reed, Roberts Assocs. Inc. v. Strauman, 40 NY2d 303, 307, 386 NYS2d 677, 680 (1976). Courts will generally enforce agreements that contain restrictive covenants only where the restrictions are reasonably limited geographically and temporally and the enforcement is necessary to protect a valid business interest. See Columbia Ribbon, 42 NY2d at 499.
The valid business interest, or protectable interest, is most often defined to include confidential customer information; where the employee performed "unique or extraordinary" services; or where necessary to protect against the misappropriation or exploitation of an employer’s goodwill, see BDO Seidman v. Hirschberg, 93 NY2d 382 (1999). In the case of covenants restraining competition, New York courts also require a demonstration that the restriction: (i) is no greater than is required for protection of the legitimate interest of the employer; (ii) does not impose undue hardship on the employee; and (iii) is not injurious to the public. Id. at 388-89.
Unfortunately, it is often difficult to decipher the legal bases that underlie many decisions in this area, and there is a host of apparent inconsistency among seemingly similar cases. This is largely because such cases are, by their very nature, exceedingly fact-intensive requiring, a fact-specific, case-by-case, analysis.
A breath of fresh air just blew in from the direction of the Appellate Division, First Department, however, in its decision in Ashland Management Inc. v. Altair Investments NA LLC, 869 NYS2d 465, 2008 N.Y. Slip Op. 10061 (1st Dept. 2008). The clarity of the decision in Ashland Management stands out from the body of somewhat confusing and at times apparently inconsistent cases in this area. In one stroke of their collective pens, the majority strengthened the enforceability of confidentiality agreements binding former employees, and at least implicitly reinforced the viability of confidentiality-based restrictions on the solicitation of the customers of one’s former employer even absent an express no-solicitation agreement.
The primary significance of the decision is the court’s enforcement of a confidentiality agreement of unlimited duration2 against two former employees. And it did so while expressly holding that it is not necessary for an employee to have provided "unique or extraordinary services" in order to justify enforcing such a perpetual confidentiality agreement. One of the former employees was a portfolio manager, and the other was involved in quantitative research. Ashland Management is in the business of providing investment advice and management to high net worth individuals and entities, and both employees left Ashland Management to form Altair Investments.
Meaning and Scope
Since long before Ashland Management, confidentiality agreements have enjoyed wider latitude than the other types of restrictive covenants. This is largely because they normally do not operate to unreasonably interfere with an individual’s ability to earn a livelihood, and because the subject of the agreement, confidential business information, is a readily identifiable protectable interest. See Geritrex Corp. v. DermaRite Indus., LLC, 910 F.Supp. 955, 959 (SDNY 1996). Moreover, an employer’s interest in its confidential or proprietary business information is so strong that a former employee is often bound not to disclose it even in the absence of an express agreement because of the common law duty of loyalty and fiduciary duty of good faith and fair dealing. See, e.g., North Atl. Instruments Inc. v. Haber, 188 F.3d 38, 47-48 (2d Cir. 1999).
Indeed, all but four of the 50 states have adopted the Uniform Trade Secrets Act (UTSA), in recognition of the recognized role of trade secrets in commerce, and one of those – New York – might well jump on the UTSA bandwagon this year3: on Feb. 26, 2009, legislation was proposed in the New York State Assembly to adopt the UTSA.4 Nevertheless, merely labeling information "confidential" or a "trade secret" is insufficient to confer legally protectable status upon it. Rather, New York courts will consider the extent to which the information is known outside the business, the measures taken to guard the information, the value of the information to the business, the amount of money or time expended in developing the information, and the ease or difficulty with which the information could be properly acquired or duplicated. See Ivy Mar Co. Inc. v. C.R. Seasons Ltd., 907 F.Supp. 547, 556 (SDNY 1995), and cases cited therein.
The permissible temporal scope of restrictive covenants has been addressed by New York courts at length, although with often dizzying variations. This results, in large part, from the extremely fact-intensive analysis required in each case. New York courts evaluate the reasonableness of temporal (as well as other) restrictions in the context of the nature of the particular industry involved, the strength and nature of the particular business interests asserted to justifying the requested restriction, and the nature of the activity being restricted. Unfortunately, however, it is difficult to discern definitive guidelines for evaluating the permissibility of a particular durational limitation in a restrictive covenant. It is axiomatic, however, that where the agreement effects a restriction on working for a competitor generally forever or prohibits solicitation of clients in perpetuity, the agreement will be unenforceable as a matter of law in New York. That is what makes the decision in Ashland so significant.
‘Ashland’ Facts and Decision
In Ashland, the First Department had before it a restrictive covenant that was limited to a confidentiality agreement which provided in relevant part that the two individual defendants would "not, at any time during or after the termination of his or her employment . . . reveal, divulge or make known to any person . . . any records, data, trade secrets, know-how, methods of operations, strategies, processes, computer programs, personnel information . . . or any other confidential or propriety information of the Company or any Client . . . used by the Company and made known . . . to the Employee by reason of his or her employment by the Company."
There was no time limitation whatsoever on the obligations of confidentiality which were imposed. Accordingly, by nevertheless finding the confidentiality agreement enforceable, the court chipped away at any blanket prohibition on unlimited durational periods for restrictive covenants – at least those limited to expressly protecting the employer’s confidential and trade secret information.
In August 2003, the individual defendants resigned from Ashland to form a competing business, Altair. In an effort to raise their profile, they distributed investment performance data to the plaintiff’s clients, contacted plaintiff’s clients to inform them of their departure, and after they had officially resigned, began soliciting plaintiff’s clients on behalf of Altair by using client contact information and performance data allegedly taken from Ashland.
Plaintiff commenced an action in January 2004 seeking damages and injunctive relief. The Supreme Court, New York County, issued a preliminary injunction enjoining defendants from "(1) using, disseminating or exploiting information derived or copied from any of Plaintiff’s records . . . and (2) soliciting any of the individual brokers, custodians or consultants of plaintiff’s institutional clients that [defendants] were either introduced to through their employee relationship with plaintiff or learned of from any of the Confidential Information." Plaintiff also sought damages for, inter alia, breach of fiduciary duty and breach of the confidentiality agreements. The Supreme Court denied defendants’ motion for summary judgment as to these causes of action, and defendants appealed.
The First Department affirmed the denial of summary judgment. The court began with the settled pronouncements of Reed, Roberts and BDO Seidman, stating that restrictive covenants are subject to specific enforcement to the extent that they are reasonable in time and geography and necessary to protect a valid interest. The court then immediately tackled the lack of a durational limit – the focus of the dissent – holding that the absence of a durational limitation does not render a confidentiality agreement void as a matter of law. While the court noted that restrictive covenants are generally unenforceable if their duration is unreasonable, the court differentiated confidentiality agreements that do not directly impact competition from other restrictive covenants, which may prevent a former employee from pursuing his or her livelihood.
Ashland is significant in its analysis of the temporal restrictions in several respects. First, by its holding, the court clarified that a temporally unlimited confidentiality agreement is not unenforceable as a matter of law. The majority distinguished itself from the dissent, which appeared to treat the confidentiality agreements at issue as classic non-compete agreements, for which the lack of a temporal restriction would indeed prove problematic. The majority further explained that contrary to what the dissent would have held, whether a former employee provided "unique or extraordinary" services is not a determining factor of enforceability but rather, a component of the analysis as to whether the covenant is temporally reasonable under the circumstances.
The court also held that a court may modify an unlimited durational restriction to one more reasonable under the circumstances, although it did not modify the restriction here. While the majority’s holding in this regard is simply an application of well-established New York law, the dissent argued that a court cannot sever an unlimited durational restriction because an unlimited restriction is, in effect, no restriction at all. The majority dismissed this form over substance argument and rested on the power of a court to enforce a covenant "to the extent it deems reasonable." See BDO Seidman, 93 NY2d at 394-395; see also Alside Div. of Associated Materials v. Leclair, 295 AD2d 873, 874, 743 NYS2d 898, 899 (3d Dept. 2002); Unisource Worldwide v. Valenti, 196 F.Supp.2d 269, 277 (EDNY 2002).
Further, the court provided exceedingly useful ammunition to employers seeking to effect a non-solicitation restriction through a confidentiality agreement. Specifically, the dissent noted that plaintiff conceded in its brief that the confidentiality agreement itself also precluded solicitation of certain clients since their very solicitation would, by definition, involve a misappropriation and use of the company’s confidential information which the employees had covenanted not to use. This was not discussed by the majority, but they were plainly aware of this point. Accordingly, Ashland Management at least implicitly reaffirms the principle that even absent an express nonsolicitation agreement, a confidentiality agreement may be effective to prohibit solicitation of customers whose identities can be known solely by reference to the employer’s confidential information. (We wouldn’t suggest arguing for an implied perpetual restriction on solicitation, however.)
Significantly, the court also reaffirmed the principle that it is not necessary to show that an employee physically took documents containing confidential information to be actionable: rather, where the individual is party to a confidentiality agreement, and the confidential information at issue constitutes a "trade secret," "whether defendants’ use of that information was a result of casual memory is irrelevant." Ashland, 869 NYS2d at 470.
Steps to Take
So what should an employer do?
• Use confidentiality agreements, as well as other restrictive covenants, but use them smartly: don’t overreach; limit them to what is necessary to protect your legitimate business interests.
• Protect your confidential information: keep it secure, both from the third parties and from your own employees who don’t have a "need to know."
• Adopt hiring and exit strategies designed to protect your confidential information. And be both vigilant and consistent.
1. Of customers or employees, the latter which, when conducted en masse, is known as "raiding."
2. The confidentiality covenant in question similarly contained no geographic restriction – a point noted by the dissent. However, the decision of the court focuses solely on the lack of a durational element, which is, accordingly, the primary focus of this article.
3. The other three states are Massachusetts, New Jersey and Texas.
4. The bill is designated A6185, and the stated purpose of it, consistent with the holdings in Ashland Management, is " . . . to provide improved trade secret protection to industry."
"Reprinted with permission from the March 23, 2009 issue of the New York Law Journal. © 2009 Incisive Media US Properties, LLC. Further duplication without permission is prohibited. All rights reserved."