Employers Should Scrutinize Non-Competes in Employment Contracts on a Case-By-Case Basis

To employers, having key employees sign non-competition agreements can be crucial to their business needs. In today’s business environment, competition is fierce and in the information age, brain power and professional knowledge are indispensable business assets. As such, the enforceability of non-competition agreements is one of the most common questions clients ask about. In general, employers seek maximum protection from their employees’ ability to resign and work for a competitor, bringing along the company’s trade secrets. However, employers are faced with state common law that is highly suspicious of non-competes because they are viewed as a restraint on trade.

Consequently, employers should not rely on boilerplate non-compete clauses in their agreements with employees. Rather, the enforceability of non-competes is highly fact dependent with each situation presenting a different legal analysis.

A recent commercial division decision lays out New York’s common law regarding the enforceability of non-competes.

On July 15, 2020, Justice Borrok of the New York County Commercial Division issued a decision in XL Diamonds LLC v. Rosen, 2020 NY Slip Op. 32354(U) regarding the enforceability of a non-competition agreement. XL Diamonds involved two competing diamond wholesalers in Manhattan, XL Diamonds and EM Diamonds. XL Diamonds alleged that, although formed in 2014, the entity employed individuals with over 30 years of experience in the industry. Because of this experience, XL Diamonds had developed a proprietary system for managing its inventory and training its sales staff, which it alleged were trade secrets that were not commercially available. In addition, XL Diamonds alleged that it had a proprietary list of customers and vendors that also constituted trade secrets.

In 2019, the defendant, Charles Rosen, contacted XL Diamonds and said that he was unhappy with his current employer, EM Diamonds, and was interested in a job with XL Diamonds. In about August 2019, XL Diamonds hired Mr. Rosen. As part of the terms and conditions of employment, Mr. Rosen signed a covenant not to compete which stated that:

during the term of this agreement, and for a period of one (1) year following the termination of employee’s employment, employee will not, either directly or indirectly, engage in/or acquire an interest in ... any business that is competitive with the business of employer. A business shall be deemed competitive for purposes of this provision if it performs services or conducts business similar to the service and business of employer, which is the wholesale diamond business via sales by the internet and/or phone and is conducted within the territory of the United States[.]

After working for XL Diamonds for a mere three and a half weeks, where he was trained and had full access to XL Diamonds’ trade secrets, Mr. Rosen resigned and returned to work for EM Diamonds. XL Diamonds alleged that by doing so, Mr. Rosen breached his covenant not to compete and that EM Diamonds conspired with Mr. Rosen to obtain XL Diamonds’ trade secrets.

Mr. Rosen moved to dismiss the complaint pursuant to CPLR § 3211 arguing that, among other things, the non-compete was unenforceable because it was overly broad.

Under New York law, a non-compete is enforceable where it (1) imposes no greater restrictions than required to protect an employer’s legitimate protectable interests; (2) does not impose undue hardship on the employee or be harmful to the general public; and (3) is reasonably limited temporally and geographically. See, e.g., Harris v. Patients Med. P.C., 93 N.Y.S.3d 299, 301 (N.Y. App. Div. 2019); Intertek Testing Servs., N.A., Inc. v. Pennisi, 2020 WL 1129773 (E.D.N.Y. Mar. 9, 2020).

In finding that the non-compete was “fatally overbroad, and the geographic scope is unreasonable”, the court noted that, as drafted, the non-compete would prevent Mr. Rosen from working in the diamond wholesale business “anywhere in the United States.” Accordingly, the court found the non-compete unenforceable and dismissed the claim alleging a breach of the non-compete agreement.

Justice Borrok’s decision focused on the restrictions in the non-compete that prevented Mr. Rosen from engaging in his chosen profession, working in the diamond wholesale business. In essence, the non-compete prevented Mr. Rosen from earning a living unless he were to switch professions or move out of the United States until the non-compete expired one year later—both of which Justice Borrok found to be unreasonable.

It is possible that a more carefully drafted non-compete that balanced XL Diamonds’ need to protect its trade secrets with Mr. Rosen’s ability to work in the diamond wholesale business would have been enforceable. For example, if XL Diamonds was concerned about Mr. Rosen contacting customers from its proprietary list of customers, the non-compete could have been drafted more narrowly to prevent Mr. Rosen from contacting those specific customers. Additionally, the geographic scope could have been narrowed to a geographic area that more appropriately represented XL Diamonds’ business interests. The question XL Diamonds could have asked was: Does XL Diamonds regularly do business “anywhere in the United States” or would a narrower scope, perhaps limited to key zip codes or counties equally have protected XL Diamonds’ business interests?

For employment lawyers, the finding in XL Diamonds is not surprising and, in fact, is all too common. Employers would be wise to more carefully examine the language of their non-compete agreements to make sure the agreement only goes as far as necessary to protect its legitimate business interests.

A significant part of our practice involves counseling clients on and litigating employment law issues. Schlam Stone & Dolan attorney Chris Dyess litigates and counsels clients regarding employment law issues including negotiating and litigating disputes over the enforceability of non-competes. Contact Schlam Stone & Dolan attorney Chris Dyess at cdyess@schlamstone.com if you or a client have questions regarding an employment dispute.