Even before these developments, New York had already set a high bar for the enforcement of non-competition and non-solicitation agreements.
A recent New York federal court decision and a proposed bill by the New York City Council may impact all New York employers who use non-competition and non-solicitation agreements.
Federal Court Denies Enforcement of Employer’s Non-Compete and Non-Solicitation Agreement
In In re Document Techs. Litig., 2017 U.S. Dist. LEXIS 104811 (S.D.N.Y. Jul. 6, 2017), the Southern District of New York denied a motion for a preliminary injunction seeking enforcement of a non-competition and non-solicitation agreement against former employees (Individual Defendants). In that case, Document Technologies, Inc. (DTI) acquired Epiq eDiscovery Solutions, Inc. (Epiq) and continued to operate Epiq as a wholly owned subsidiary. Epiq had required their employees, including the Individual Defendants, to sign employment agreements containing numerous restrictive covenants, including a one-year non-competition agreement, a one-year prohibition on soliciting the company’s clients, and a one-year prohibition on soliciting the company’s employees.
One of the Individual Defendants was contacted by a recruiter regarding an employment opportunity at LDiscovery, LLC (LDisovery), a competitor of Epiq’s, and then communicated the opportunity to the rest of the Individual Defendants. After negotiations, the Individual Defendants resigned from Epiq and entered into employment agreements with LDiscovery where they would not work for LDiscovery for a year and, in return, would be paid signing bonuses between $1,200,000 and $1,400,000. LDiscovery further agreed to indemnify the Individual Defendants for attorneys’ fees and damages relating to their transition from Epiq to LDiscovery.
DTI argued the Individual Defendants breached the terms of their non-competition covenants by executing employment agreements with LDiscovery and participating in meetings to discuss strategy once the Individual Defendants were active employees at LDiscovery. The Court rejected this argument, holding that a “former employee may prepare to compete during the term of a non-competition provision… .” Legitimate preparatory acts include incorporating a later competing business; building facilities; and filing and obtaining trademarks. The Court stated acts cease to be preparatory when they “detrimentally impact the former employer’s economic interests” during the term of the non-competition clause, but the Individual Defendants did not cross that line as their acts were merely preparatory.
DTI also argued the Individual Defendants breached their employee non-solicitation clauses by jointly searching for new employment. The Court held that this clause was unenforceable to the extent it prohibited at-will employees, who have not accepted an offer of new employment, from inducing or encouraging their co-workers to leave their present employer. An employee non-solicitation clause is reasonable, and thus enforceable, if it: (1) is no greater than is required for the protection of the legitimate interest of the employer; (2) does not impose undue hardship on the employee; and (3) is not injurious to the public. DTI argued the clause prevented the potential harm to company operations arising from the coordinated mass resignation of several employees. The Court held this was not a legally cognizable interest for the purposes of a restrictive covenant. The Court stated if DTI desires to prevent employees from coordinating their resignations, it is free to hire them pursuant to term employment agreements. The Court found the clause to impose an undue hardship on DTI’s employees because it prohibited any speech that “encourages” or “induces” an employee to terminate his or her employment. The Court found such a restriction to be a “contractual gag rule on employee complaints.” The Court additionally found the clause injurious to the public because it “serves to keep departing employees in the dark about job opportunities beyond DTI.” The Court stated the public interest strongly supports the free flow of information concerning alternative employment.
New York City Proposes Partial Ban on Non-Compete Agreements
On July 20, 2017, the New York City Council proposed new legislation that would prohibit New York City employers from entering into a non-competition agreement with any “low-wage employee.” The bill defines “low-wage employee” to mean any non-exempt employee, other than manual workers, railroad workers or commission salespersons. To be properly classified as exempt under the New York Labor Law, the employee must be employed in a bona fide executive, administrative or professional capacity and receive earnings in excess of $900 per week.
The proposed bill would also prohibit New York City employers from requiring any potential employees (i.e., non-low-wage employees) to enter into a non-compete agreement unless, at the beginning of the hiring process, the employer discloses in writing that the prospective employee may be subject such an agreement.
If passed by the New York City Council, the bill is likely to be signed by Mayor Bill de Blasio and would take effect 120 days after being signed into law. The law would not apply to agreements entered into before the bill’s effective date.
What This Means for Employers
Even before these developments, New York had already set a high bar for the enforcement of non-competition and non-solicitation agreements. The In re Document Techs. Litig. case is a further indication that New York Courts will closely scrutinize restrictive covenants. It is not enough for employers to have their employee sign non-competition and non-solicitation agreements. For these agreements to be enforceable, employers must be able to state a legitimate business interest as to why they are necessary, and the agreements must be narrowly tailored to protect this legitimate business interest. For high-level employees, companies may try to get around non-competition restrictions by hiring an employee and then having the employee take a sabbatical year, which the Court in In re Document Techs. Litig. found to not violate the non-competition restriction at issue. Regarding employee non-solicitation agreements, preventing a mass exodus of employees is not a legitimate business interest. Employee non-solicitation agreements will only be enforceable to protect against unfair competition.
While the New York City Council bill has only been proposed and is not law, it follows the growing trend in New York to attack restrictive covenant agreements. The New York attorney general has challenged non-compete agreements viewed to be overly broad, and just last October, proposed legislation largely mirroring the New York City Council bill. It is possible that New York State legislation limiting the use of restrictive covenants will follow the New York City bill. We will continue to monitor these legislative developments.