United States: When Blue Penciling Fails To Come To The Rescue: New York Federal Court Refuses Partial Enforcement Of Restrictive Covenant

Since the landmark New York Court of Appeals decision in BDO Seidman v. Hirshberg, 93 N.Y. 2d 382 (1999), the restrictive covenant landscape in New York has remained relatively constant. Throughout this period, New York employers have relied on the safety net of the state's liberal “blue pencil rule,” under which a court could narrow an overbroad covenant but still enforce it to the maximum permissible extent. However, the Southern District of New York recently declined to blue-pencil a former employee's overly broad restrictive covenant and instead found the employer's restrictions void and unenforceable. This decision may open the door for more New York judges to forgo partial enforcement, and employers should reexamine their restrictive covenants to ensure maximum enforceability.

Restrictive Covenants in New York: Then and Now

For more than 20 years, New York employers have operated under the guidance of BDO Seidman in constructing restrictive covenants to protect their businesses. BDO Seidman held that restrictive covenant provisions may be enforced if (i) reasonable in duration and geographic scope, (ii) necessary to protect the employer's legitimate interests, (iii) not harmful to the public, and (iv) not unreasonably burdensome to the employee.

In BDO Seidman, the Court of Appeals also addressed judicial discretion to partially enforce restrictive covenants, instructing courts to determine whether blue penciling is appropriate by “conduct[ing] a case specific analysis, focus[ed] on the conduct of the employer in imposing the terms of the agreement.” In a cautionary note, the court raised concerns that employers might impose unreasonable and overly restrictive covenants with the assumption that a reviewing court would modify problematic provisions rather than void the entire agreement, and prescribed that modification can be justified only where “the employer demonstrates an absence of overreaching, coercive use of dominant bargaining power, or other anti-competitive misconduct, but has in good faith sought to protect a legitimate business interest, consistent with reasonable standards of fair dealing.” Although rare, several New York courts have entirely stricken overbroad restrictive covenants rather than modify them and allow partial enforcement. (See our prior Employment Law Update addressing some of these cases.)

In Flatiron Health, Inc. v. Carson, 19 Civ. 8999 (VM), 2020 U.S. Dist. LEXIS 48699 (S.D.N.Y. March 20, 2020), Flatiron Health, Inc. (Flatiron), sued a former employee to enforce restrictive covenants that prohibited competitive activity and solicitation of Flatiron clients and employees for one year following his separation from employment. Judge Victor Marrero of the Southern District of New York acknowledged the “judicial power to sever and grant partial enforcement for an overbroad employee restrictive covenant” but nonetheless found that Flatiron did not demonstrate “its entitlement to partial enforcement.”

Specifically, the court questioned Flatiron's good faith given the vagueness and overbreadth of the noncompetition covenant, which encompassed entities with which the company did not compete and prohibited any form of employment with such companies, including, as Flatiron's chief executive officer conceded, a janitorial position. The court also deemed the nonsolicitation provision unenforceable because, critically, the provision did not differentiate between Flatiron customers with whom the former employee had working relationships and those with whom he did not. Finally, the court pointed to the employer's practice of requiring all employees, regardless of position, to agree to the same restrictive covenants as evidence suggesting that Flatiron did not, in good faith, ask the former employee “to bear only those restrictions Flatiron deemed ‘necessary to protect its legitimate business interests.'” In the face of conduct the court found to be in bad faith, Judge Marrero declined to modify the overbroad provisions and instead deemed the restrictive covenants unenforceable.

Lessons Learned

New York employers should ensure that restrictive covenants are justified by a legitimate business need and narrowly drafted to reasonably protect confidential information and customer and other relationships. Employers should consider the following when constructing restrictive covenants:

• A “one size fits all” restrictive covenant given to all employees, regardless of seniority level or role, may be subject to attack. Employers should consider crafting different restrictive covenants for different roles. Indeed, for some roles, it may be appropriate not to require any restrictive covenants and to instead rely only on nondisclosure obligations.
  
  
• The narrower the scope of prohibited competitive activity, the greater the likelihood of enforcement. The court in Flatiron Health was skeptical of the employer's conduct because the definition of competition included businesses that were not truly competitive with Flatiron and prohibited any work for such entities, even if there was no reasonable risk of misuse of confidential information or usurpation of customer goodwill.
  
  
• Consider limiting customer nonsolicitation provisions to those customers with whom the employee has had contact (or had access to confidential information) during a reasonable lookback period. The Flatiron Health court identified the employer's lack of distinction between customers with whom the former employee had developed relationships and the rest of the customer base as problematic. The court cited BDO Seidman in stating that “an employer does not have a legitimate interest in the preservation of its ‘entire client base where, as here, there is no evidence that the employee obtained a competitive advantage by using confidential information.'”
  
  
• Consider similarly limiting employee nonsolicitation provisions in the same manner.
  
  
• Select a reasonable duration for post-employment restrictions. Consider what the provision is intended to protect and how quickly confidential information or customer relationships may become stale.
  
  
• Be mindful of the geographic scope of restrictions. If a company operates only in New York and has no ties to other states, and the business is local, a nationwide noncompete may be unreasonably overbroad.

When drafting restrictive covenants, employers should be mindful of the standards articulated in BDO Seidman v. Hirshberg and ensure they can demonstrate that the covenants they require are not the result of “overreaching, coercive use of dominant bargaining power, or other anti-competitive misconduct” and are instead a good faith attempt to protect a legitimate business interest consistent with existing case law.

For assistance in drafting restrictive covenants or questions about the implications of Flatiron Health, please contact a member of the Kramer Levin Employment Department.

Originally published by Kramer Levin, July 2020

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