May 2014 Employer Update New York’s Appellate Court Sends a Warning Shot to Employers Regarding Choice-of-Law Provisions in Restrictive Covenant Agreements By Gary D. Friedman and Celine J. Chan In This Issue 1New York’s Appellate Court Sends a Warning Shot to Employers Regarding Choiceof-Law Provisions in Restrictive Covenant Agreements 6The Enforceability in California of Choice-of-Law Provisions and Forum Selection Clauses in Non-Compete Agreements On February 7, 2014, in Brown & Brown, Inc. v. Johnson, 115 A.D.3d 162, 980 N.Y.S.2d 631 (4th Dept. 2014), leave to appeal granted, 2014 WL 1767093 (4th Dept. May 2, 2014), the New York Appellate Division, Fourth Department, issued a significant warning to employers who often include choice-of-law provisions in their employment agreements, that even if the chosen state’s law bears a reasonable nexus to the transaction at issue, such provisions may not necessarily be enforced by New York courts if they are inconsistent with New York’s strong public policy concerning restrictive covenants. Specifically, Johnson should cause employers to carefully evaluate governing law provisions in agreements containing restrictive covenant clauses, and their enforceability where other states’ public policies regarding such restraints are distinct. In refusing to apply an employment agreement’s Florida choice-of-law provision, the Johnson Court found that Florida law concerning restrictive covenants offended the public policy of the Court’s sitting state, New York. According to the Appellate Division decision, the state of the parties’ chosen law must not only bear a reasonable relationship to the parties’ transaction, but it also cannot be “truly obnoxious” to New York’s public policy. Moreover, and of equal significance to employers, the Appellate Division held that a severability clause, which is common in most restrictive covenant agreements, may not help save an otherwise unenforceable restrictive covenant where the court determines that the employer sought to exploit its superior bargaining power over the employee. Case Background In December 2006, Theresa A. Johnson (Johnson) was hired by plaintiffs, Brown & Brown, Inc. (B&B) and Brown & Brown of New York, Inc. (B&B NY), insurance brokers, to provide actuarial services for plaintiffs.1 B&B was the Florida parent company of B&B NY, one of its operating subsidiaries, which employed Johnson.2 The parent company directed sales strategies, set sales goals, and provided promotional and educational material for B&B NY.3 Johnson’s salary was administered in Florida and paid from a Florida bank account.4 On her first day of work, Johnson was presented with an employment agreement with a non-solicitation clause, a confidentiality provision, and an employee non-inducement covenant.5 There was no non-competition Weil, Gotshal & Manges LLP Employer Update provision in Johnson’s agreement, a point that would later be addressed by the Court. The non-solicitation provision prohibited Johnson from soliciting or servicing any client of plaintiffs’ New York offices for two years following termination, and was not merely limited to the clients whom Johnson serviced or with whom she otherwise interacted.6 The confidentiality covenant prohibited Johnson from disclosing plaintiffs’ confidential information or from using it for her own purposes.7 The non-inducement covenant prohibited Johnson from inducing or convincing plaintiffs’ New York employees to leave employment with plaintiffs for two years following termination.8 The employment agreement was made and entered into among Johnson, B&B, and B&B NY, and stated that it would be “governed by and construed and enforced according to Florida law.”9 According to the [New York] Appellate Division decision, the state of the parties’ chosen law must not only bear a reasonable relationship to the parties’ transaction, but it also cannot be “truly obnoxious” to New York’s public policy. In February 2011, Johnson was involuntarily terminated without cause by plaintiffs, and she subsequently obtained employment with defendant Lawley Benefits Group, LLC, an industry competitor. Johnson’s former employers immediately brought suit asserting four causes of action against Johnson and/or her subsequent employer for: (i) breach of the non-solicitation, confidentiality and non-inducement covenants; (ii) misappropriation of confidential, and proprietary information; (iii) tortious interference with prospective and existing business relations; and (iv) tortious interference with, and inducement to breach, the employment agreement.10 Weil, Gotshal & Manges LLP On defendants’ motion for summary judgment, the New York trial court determined that the Florida choice-of-law provision in the employment agreement was unenforceable because the agreement “bore no reasonable relationship to the state of Florida,” and that New York law should govern the contract claims.11 It also granted defendants’ motion with respect to plaintiffs’ first cause of action, except to the extent plaintiffs could establish that Johnson violated the non-solicitation covenant of the agreement, granted defendants’ motion with respect to the second and third causes of action, and denied the motion as to plaintiffs’ fourth cause of action. Upon plaintiffs’ motion for reargument, the trial court reinstated the non-inducement breach portion of plaintiffs’ first cause of action.12 The Fourth Department’s Decision On appeal, the Fourth Department addressed four issues, all of which arise frequently in employment agreements containing restrictive covenants: (i) whether to enforce the Florida choice-of-law provision; (ii) whether employers can enforce restrictive covenants against employees who are involuntarily terminated without cause; (iii) whether the nonsolicitation provision was overbroad; and (iv) whether the court must partially enforce an overbroad nonsolicitation provision where the agreement expressly provides for partial enforcement. The Fourth Department agreed with the trial court that the Florida choice-of-law provision was unenforceable, albeit for a significantly different reason. Indeed, contrary to the trial court’s findings, the Court concluded that Florida law “bears a reasonable relationship to the parties or the transaction[,]”13 as the parent company has a strong nexus with Florida and essentially directed and controlled its subsidiary, B&B NY. But that reasonable relationship was insufficient to uphold the stated choice-of-law provision because, according to the Fourth Department, the chosen law also “must not be ‘truly obnoxious’ to New York’s public policy.”14 In this case, the Court concluded that Florida law ‒ which has specific state statutes governing the enforceability of restrictive covenants ‒ was, in certain material respects, at odds with New York’s public policy concerning restrictive covenants. May 2014 2 Employer Update Specifically, in analyzing the enforceability of Johnson’s non-solicitation provision, the Court focused on two aspects of Florida restrictive covenant law that conflicted with, and were “truly obnoxious” to, New York law and public policy. First, Florida law expressly forbids, by statute, courts from considering the economic or other hardship imposed upon an employee by a restrictive covenant in evaluating the reasonableness of the covenant,15 whereas the determination under New York law requires an evaluation of whether a restrictive covenant “that imposes an undue hardship on the restrained employee is invalid and unenforceable.”16 Second, Florida law requires that courts must construe a restrictive covenant “in favor of providing reasonable protection to all legitimate business interests established by the person seeking enforcement,” whereas under New York law, restrictive covenants are “almost uniformly disfavored” unless they comply with prevailing standards of reasonableness.17 Significantly, and of importance to all employers seeking to enforce restrictive covenants, the Appellate Division construed the non-solicitation of client provision in this case as a covenant not to compete, as Florida law views all “restrictive covenants” as one category of provisions including any restraint on trade.18 However, to the extent the Fourth Department is suggesting that reasonably tailored client nonsolicitation provisions, limited to clients with which the employee interacted directly during employment, are disfavored to the same extent that New York courts disfavor broader non-compete covenants, that view may not be an accurate assessment of New York law on the subject. Indeed, New York courts have expressed the view that non-competition provisions are disfavored (albeit enforceable under certain circumstances) under New York law,19 but that nonsolicitation covenants are more palatable because an “employer has a legitimate interest in preventing former employees from exploiting or appropriating the goodwill of a client or customer, which has been created and maintained at the employer’s expense[.]”20 judgment because Johnson was involuntarily terminated without cause. In support of their argument, the defendants had relied on a New York Court of Appeals decision, Post v. Merrill Lynch, Pierce, Fenner & Smith, 48 N.Y.2d 84 (1979), in which the New York high court declined to enforce a forfeiture-for-competition clause because the employees were involuntarily terminated without cause. But in this case, the Fourth Department declined to extend Post to restrictive covenants that do not involve forfeiture-for-competition clauses, such as in Johnson’s agreement.21 Moreover, while the Court noted that there were issues of fact as to whether Johnson was terminated “without cause,” the Court also declined to establish a per se rule that involuntary termination “without cause” renders restrictive covenants unenforceable. The Court further determined that Johnson’s nonsolicitation clause was overbroad and therefore unenforceable because it unreasonably sought to bar Johnson from soliciting clients of the plaintiffs with whom she “never acquired a relationship through [her] employment.”22 More specifically, according to the Fourth Department, the non-solicitation provision purported to unreasonably restrict Johnson from soliciting, diverting, or accepting, either directly or indirectly, “any insurance or bond business of any kind or character from any person, firm, corporation, or other entity that is a customer or account of the New York offices of the Company” without regard to whether Johnson acquired a relationship with those clients.23 Having determined that the law of New York should govern the enforcement of the employment agreement, the Court rejected the defendants’ contention that they were entitled to summary Significantly, and as a warning to employers who draft such provisions, the Court also rejected the plaintiffs’ argument that the Court should partially enforce the covenant, even though the agreement expressly called for partial enforcement in the event portions were deemed invalid. Such severability clauses in restrictive covenant agreements are standard protections against findings of enforceability of one or more covenants. However, relying on BDO Seidman v. Hirschberg, a seminal New York Court of Appeals decision relating to severability and partial enforcement,24 the Appellate Division identified three bases to support its decision. First, the Court found that Johnson had received no benefit or consideration in exchange for agreeing to the overbroad non-solicitation provision Weil, Gotshal & Manges LLP May 2014 3 Employer Update beyond continued employment. Second, it observed that plaintiffs were on notice that the non-solicitation provision it proposed to Johnson was overbroad because the BDO Seidman decision had been rendered more than seven years earlier, leaving no doubt that restrictive covenants needed to be narrowly tailored to protect the employer’s legitimate business interests, and nothing more.25 Third, the Court was concerned that granting plaintiffs partial enforcement of the non-solicitation covenant ‒ as opposed to voiding it entirely ‒ would incentivize employers to “use their superior bargaining position to impose unreasonably anti-competitive restrictions …[,]” knowing that they could fall back on partial enforceability.26 Significant Implications for Employers In the wake of Johnson, employers seeking to maximize the enforceability of their restrictive covenant agreements with out-of-state employees ‒ particularly those with employees in New York ‒ will not only need to establish that a chosen state’s laws bear a reasonable relationship to the transaction, but also will need to scrutinize both states’ restrictive covenant laws and public policies to analyze any material variances or conflicts between the chosen law and the law of the forum state. Johnson is particularly significant because employers that operate in multiple jurisdictions often select a choiceof-law provision that is more employer-friendly, like Florida, where possible. But Johnson’s impact on choice-of-law provisions goes well beyond the dichotomy between Florida and New York law. To wit, the Johnson court specifically referred to three other states, Illinois,27 Alabama,28 and Georgia,29 that have also determined that Florida law conflicts with their public policies concerning restrictive covenants. Undoubtedly, post-Johnson, employers that choose to select more employer-friendly states’ governing laws should consider at least two prophylactic measures beyond ensuring, at a minimum, that the transaction at hand bears a reasonable relationship to the chosen state’s governing law. First, employers should draft restrictive covenants that at least colorably could be found enforceable under even the more employeefriendly state law of the sitting court. Indeed, an overbroad and overreaching restrictive covenant will Weil, Gotshal & Manges LLP only further highlight for the court the stark contrast between two states’ respective policies, to the extent one state is more employer-friendly than the other, or forbids consideration of certain factors that the other requires. Second, employers should be prepared to demonstrate factually why the chosen state’s law is reasonable when applied to the restrictive covenant, why the chosen state’s law does not offend the public policy of the state in which the action is venued, and why application of the chosen state’s law would not lead to unreasonably harsh results. Employers should also recognize that while the Johnson court focused its analysis on the enforceability of a nonsolicitation provision, it construed this provision as if it were a more restrictive non-compete provision, an approach which might surprise many employers who may believe that they are enhancing the likelihood of enforcing their non-solicitation covenants by not including a more restrictive non-compete provision. Johnson also serves as a warning to employers that even an express severability provision will not necessarily save an otherwise overbroad or overreaching restrictive covenant. In BDO Seidman, the New York Court of Appeals adopted what it labeled the more “flexible position” with respect to partial enforcement, holding that where the employer demonstrates that it did not overreach, and in good faith sought to protect its legitimate business interests consistent with reasonable standards of fair dealing, partial enforcement may be justified.30 However, where an employer offers only employment or continued employment as consideration, where an employer has been put on notice that its restrictive covenant is overbroad by earlier enforcement decisions, and where an employer is in a superior bargaining position (which is often the case), New York courts may not hesitate to strike the unreasonable restrictive covenant in its entirety. Notwithstanding Johnson, the Fourth Department’s severability holding may not be illustrative of the views of other departments in the Appellate Division, but rather highlights that such a severability inquiry necessarily involves assessing the specific factors identified in BDO Seidman. In all events, in light of the Court’s reasoning in Johnson, employers are advised not to assume that they knowingly can risk May 2014 4 Employer Update overreaching in drafting restrictive covenants, and simply expect a court to save them by carving out those more unpalatable provisions. Rather, employers should review carefully, and draft within, the current, acceptable contours of restrictive covenants (with which courts will expect employers to be familiar), consider offering employees more than continued employment as consideration, and ensure that employees are given sufficient time to consider the covenants and review their options with counsel. 22.Id. (citing Scott, Stackro & Co., C.P.A.’s, P.C. v. Skavina, 780 N.Y.S.2d 675 (3d Dept. 2004) and BDO Seidman, 690 N.Y.S.2d 854). 1. Brown & Brown, Inc. v. Johnson, 980 N.Y.S.2d 631, 635 (4th Dept. 2014). 26.Johnson, 980 N.Y.S.2d at 641. 2. Id. at 636. 3. Id. at 635. 4. Id. 5. Id. 6. Id. 7. Id. 23.Id. at 639-40. 24.In BDO Seidman, the Court also held that a restrictive covenant was overbroad to the extent it applied to clients the defendant had not served significantly while employed, held that partial enforcement of the restrictive covenant was warranted, and then remitted on the issue of the validity of a liquidated damages provision. 25.BDO Seidman, 690 N.Y.S.2d at 859. 27.Brown & Brown, Inc. v. Mudron, 887 N.E.2d 437 (Ill. App. Ct. 3d Dist. 2008). 28.Unisource Worldwide, Inc. v. South Central Alabama Supply, LLC, 199 F. Supp.2d 1194 (M.D. Ala. 2001). 29.Carson v. Obor Holding Company, LLC, 734 S.E.2d 477 (Ga. Ct. App. 2012). 30.BDO Seidman, 690 N.Y.S.2d at 861. 8. Id. 9. Id. at 635-36. 10.Id. at 635. 11.Id. 12.Id. at 635-36. 13.Id. at 636. 14.Id. 15.FLA. STAT. § 542.335(1)(g)(1). 16.Johnson, 980 N.Y.S.2d at 637 (citing BDO Seidman v. Hirshberg, 690 N.Y.S.2d 854 (1999)). 17.Id. 18.Id. at 638. 19.Ticor Title Ins. Co. v. Cohen, 173 F.3d 63, 69 (2d Cir. 1999); see also Greenwich Mills Co. v. Barrie House Coffee Co., 91 A.D.2d 398, 401 (2d Dept. 1983) (explaining that in evaluating the enforceability of a restrictive covenant, “much will depend on whether the covenant involves a total ban on competition with the former employer or … the far lesser restriction of a ban on solicitation of its customers.”). 20.BDO Seidman, 690 N.Y.S.2d at 391-92. 21.Johnson, 980 N.Y.S.2d at 639. Weil, Gotshal & Manges LLP May 2014 5 Employer Update The Enforceability in California of Choice-of-Law Provisions and Forum Selection Clauses in Non-Compete Agreements By Christopher J. Cox, David R. Singh, and Bambo Obaro The ability to prevent a key employee from joining a competitor is becoming increasingly important in the current business climate where employees are often one of the most valuable assets of a company. While non-compete agreements are generally an effective way to accomplish this goal, the law on the enforceability of non-compete agreements is not uniform across all states. Therefore, seeing that the law best suited for your business is applied in any subsequent dispute is crucial when drafting noncompete agreements. Choice-of-Law Provisions Choice-of-law provisions are generally an effective way of choosing the governing law at the time of contract formation. A company often picks the law of a favorable, defensible jurisdiction and assumes that it is adequately protected. However, courts in some jurisdictions will not enforce a foreign state choice-oflaw provision if the court determines that the forum state has a materially greater interest in applying its own laws. For example, several California courts have found under the facts and circumstances presented, that California’s strong public policy in favor of employee mobility trumped a choice-of-law provision in a noncompete agreement where the chosen law conflicted with California law. California public policy in favor of employee mobility and against restraints of trade is codified in California Business and Professions Code Section 16600. Pursuant to Section 16600, noncompete agreements are invalid under California law unless they fall within one of three narrow statutory exceptions. See, e.g., Cal. Bus. & Prof. Code § 16600 (“every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void”); Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 942 (2008) (“We conclude that section 16600 prohibits employee non- Weil, Gotshal & Manges LLP competition agreements unless the agreement falls within a statutory exception”). In determining the enforceability of choice-of-law provisions, California courts will first determine (1) whether the chosen state has a substantial relationship to the parties or their transaction, or (2) whether there is any other reasonable basis for the parties’ choice of law. If neither test is met, the court will not enforce the parties’ choice of law. If, however, either test is met, the court will next look to whether application of chosen state’s law would be contrary to a fundamental policy of California. If there is no such conflict, the court will enforce the parties’ choice of law. If, however, there is a fundamental conflict with California law, the court will then determine whether California has a materially greater interest than the chosen state in the determination of the particular issue. If California has a materially greater interest than the chosen state, the choice of law shall not be enforced. Nedlloyd Lines B.V. v. Superior Court, 3 Cal. 4th 459, 464-66 (1992). In applying this test when evaluating restraints on trade, California courts have often found based upon the facts and circumstances presented, that California has a materially greater [S]everal California courts have found under the facts and circumstances presented, that California’s strong public policy in favor of employee mobility trumped a choice-oflaw provision in a non-compete agreement where the chosen law conflicted with California law. interest in the application of its laws in the context of non-compete agreements and that California’s interests would be more seriously impaired by application of the chosen state’s laws. See Application Grp., Inc. v. Hunter Grp., Inc., 61 Cal. App. 4th 881, May 2014 6 Employer Update 902, 72 Cal. Rptr. 2d 73, 86 (1998) (“California has a materially greater interest than does Maryland in the application of its law to the parties’ dispute, and … California’s interests would be more seriously impaired if its policy were subordinated to the policy of Maryland.”); Davis v. Advanced Care Technologies, Inc., CVS06 2449 RRB DAD, 2007 WL 2288298 (E.D. Cal. Aug. 8, 2007) (“California has a ‘materially greater interest’ in the outcome of this case than Connecticut, and … California’s interests would be more seriously impaired by enforcement of the parties’ contractual choice-of-law provision than would the interests of Connecticut if California law were applied.”) Each state has its own conflicts of laws approach and tolerance, or lack thereof, for non-compete agreements. Indeed, several courts outside of California have also considered this issue and chose to disregard the parties’ choice of law. See DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 680-81 (Tex. 1990) (collecting cases) but see DGWL Investment Corp. v. Giannini, C.A. No. 8647-VCP (Del. Ch. 2013) (finding that although California had a significant interest in the resolution of the case because all of the parties were located in California and the agreement was negotiated in California, it was not materially greater than Delaware’s interest. Indeed, when parties have ordered their affairs voluntarily through a binding contract, Delaware law is strongly inclined to respect their agreement, and will only interfere upon a strong showing that dishonoring the contract is required to vindicate a public policy interest even stronger than freedom of contract.) Thus, even if the parties include a choice-of-law provision designating a foreign state’s law as governing an employment contract, it should not be considered risk free. Forum Selection Clauses Although many jurisdictions will apply the law of the forum rather than honor the parties’ choice of law when determining the enforceability of a non-compete agreement, the chances of those courts respecting forum selection clauses are much higher. For example, despite California’s strong public policy against the enforcement of non-compete agreements under California law, forum selection clauses are Weil, Gotshal & Manges LLP considered prima facie valid and enforceable unless the party challenging enforcement shows the clause is unreasonable under the circumstances. A forum selection clause may be deemed unreasonable if (1) its incorporation into the contract was a result of fraud, undue influence, or overweening bargaining power, (2) the selected forum is so gravely difficult and inconvenient that the complaining party will for all practical purposes be deprived of its day in court, or (3) the enforcement of clause would contravene strong public policy of forum in which suit is brought. Swenson v. T-Mobile USA, Inc., 415 F. Supp. 2d 1101 (S.D. Cal. 2006). Although parties challenging the application of a forum selection clause have argued that sending a case to a jurisdiction that enforces noncompete agreements would contravene California’s strong public policy in favor of employee mobility, this argument has gained little traction in California. This issue was squarely addressed in Swenson, where the plaintiff argued that enforcement of the forum selection clause (which required claims to be brought in Washington) would undermine California Business and Professions Code Section 16600 and that, being free to argue for application of California law in another jurisdiction; the reality is that forum states apply their own law. Id. at 1104. In rejecting this argument, the court held that the plaintiff was impermissibly combining the forum selection and choice-of-law analyses by arguing that enforcement of the forum selection clause results in the application of a Washington law which is violative of California public policy. The court further noted that while a Washington court’s application of Washington law to the non-compete agreement at issue may arguably lead to a result conflicting with the provisions of Section 16600, the plaintiff was free to argue for the application of California law and the Washington court could choose to apply it if appropriate. Id. The use of forum selection clauses to maximize the chances of prevailing on a choice-of-law dispute is often overlooked. Yet, the inclusion of such a provision in an employment agreement may make the difference between retaining a company’s most-prized assets or seeing them leave for the competition. May 2014 7 Employer Update Employer Update is published by the Employment Litigation and the Executive Compensation and Employee Benefits practice groups of Weil, Gotshal & Manges LLP, 767 Fifth Avenue, New York, NY 10153, +1 212 310 8000, www.weil.com. If you have questions concerning the contents of this issue, or would like more information about Weil’s Employment Litigation and Executive Compensation and Employee Benefits practices, please speak to your regular contact at Weil, or to the editors or practice group members listed below: Editor: Lawrence J. Baer [email protected] +1 212 310 8334 [email protected] +1 212 310 8578 Associate Editor: Millie Warner Practice Group Members: Jeffrey S. Klein Practice Group Leader New York +1 212 310 8790 [email protected] Frankfurt Stephan Grauke +49 69 21659 651 [email protected] London Joanne Etherton +44 20 7903 1307 [email protected] Miami Edward Soto +1 305 577 3177 [email protected] New York Lawrence J. Baer +1 212 310 8334 [email protected] Steven M. Margolis +1 212 310 8124 [email protected] Amy M. Rubin +1 212 310 8691 [email protected] Michael Nissan +1 212 310 8169 [email protected] Paul J. Wessel +1 212 310 8720 [email protected] Nicholas J. Pappas +1 212 310 8669 [email protected] Gary D. Friedman +1 212 310 8963 [email protected] Ivor Gwilliams +44 20 7903 1423 [email protected] © 2014 Weil, Gotshal & Manges LLP. All rights reserved. Quotation with attribution is permitted. This publication provides general information and should not be used or taken as legal advice for specific situations that depend on the evaluation of precise factual circumstances. The views expressed in these articles reflect those of the authors and not necessarily the views of Weil, Gotshal & Manges LLP. If you would like to add a colleague to our mailing list, please click here. If you need to change or remove your name from our mailing list, send an email to [email protected]. Weil, Gotshal & Manges LLP May 2014 8
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