NY Rulings Show How Reasonable Noncompetes Work In M&A
January 28, 2022 – Law360 Expert AnalysisPublished in Law360 Expert Analysis
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The COVID-19 pandemic has unleashed a wave of employee resignations that has earned the moniker of the Great Resignation.[1]
According to recent reports, over 38 million workers quit their jobs in 2021 in search of, among other things, higher pay, better working conditions or remote work opportunities. At the same time, deal-making remains at historically high levels. According to a recent KPMG report, "2021 was a blowout year for M&A — 2022 could be even bigger."[2]
Both of these trends will result in a continuing focus on the enforceability of noncompetition and other restrictive covenants, which have come under increasing scrutiny.[3]
Generally speaking, restrictive covenants ancillary to employment agreements are scrutinized in New York and other jurisdictions, and they typically will not be enforced for more than a limited period of time.
On the other hand, courts in New York and elsewhere take a less strict approach with regard to restrictive covenants in the sale of business context and will usually enforce them for longer periods of time than in the employment context.
But what about when the seller of the business goes to work for the buyer? Will the traditional justification of enforcing a noncompete in the sale of business context — the protection of the goodwill the seller has purchased— extend to imposing a noncompete on the seller after he or she terminates employment with the buyer, even if the termination is several years after the sale's closing?
Two recent decisions from the New York Appellate Division's First Department — Bruderman Bros. LLC v. Goldberg[4] on April 8, 2021 and Newmark Partners LP v. Hunt[5] on Dec. 16, 2021 — answered in the affirmative, at least within the context of the facts presented in those cases.
The court in Bruderman and Newmark — applying New York law and Delaware law, respectively — permitted the buyer to enforce the noncompete from the date of the employees' departure, even though the employees' departure occurred more than six years after the sales in those cases.
Moreover, in reaching its decision, the Newmark court declined to adopt the arguments of the former employees — three real estate brokers from Colorado citing conflicting Colorado authority — that such enforcement was unreasonable as the six plus years between the date of closing and their departure was more than sufficient time for Newmark to convert the goodwill it acquired to its own.
Restrictive Covenants in Employment or Sale of Business Contexts
It is well known that noncompete and other restrictions in the employment context are closely reviewed.
Where restrictive covenants are incidental to the sale of business, however, courts generally take a less strict approach. Indeed, the enforcement of such restrictions has been described as "not only desirable, but essential."
The enforcement of these restrictions is rooted in protecting the buyer's purchase of the seller's goodwill of the very business that was transferred for value. Thus, the restrictions will be enforced if "not more extensive, in terms of time and space, than is reasonably necessary to the buyer for the protection of his legitimate interest in the enjoyment of the asset bought."
Courts have typically enforced restrictions ancillary to the sale of business for longer periods than to employment.
The following sections discuss three cases — two from New York and one from Colorado — that addressed the situation where the seller/owner of a business goes to work for the buyer, and the seller/owner, as employee, agreed to refrain from competing not only for several years after the closing, but also following his departure from employment.
Bruderman v. Goldberg
The Bruderman Bros. case involved the seller of a financial planning business who sold his company to the Bruderman companies in 2014, and thereafter became their employee.
The purchase agreements contained a noncompete which restrained the seller from engaging in the broker/dealer and investment advising business until:
[T]he last to occur of ... the six (6) year anniversary of the Closing Date and ... the two (2) year anniversary of the date [the seller ceased his employment].
A dispute arose between seller and the Bruderman companies in 2019, leading the Bruderman companies to terminate the seller's employment and sue the seller for breach of the parties' agreements.
The Bruderman companies also sought an injunction in aid of arbitration to enforce the restrictive covenants.
The New York Supreme Court granted the injunction, finding in relevant part that it would seem "at this provisional stage that [employee] may not compete with the Bruderman Companies until" 2021 — two years after the seller ceased employment.
The First Department affirmed, reasoning that the defendant had "sold his investment brokerage and advisory business for a significant sum, and agreed to work for plaintiffs for five years for further substantial consideration."
The appellate division further held that the trial court "providently exercised its discretion" and it "cannot be said that the governing agreements' restrictive covenants, and in particular the noncompete provision, were overbroad, as restraints on trade" including in terms of "geographical or temporal scope."
According to the court, "an adjudicator could likewise find that defendant's services were unique or extraordinary for purposes of enforcement of the noncompete provision."
Newmark v. Hunt
Newmark involved three Colorado-based real estate brokers who joined Newmark after Newmark purchased their interests in their former real estate brokerage in 2014.
Under the purchase agreement, each broker agreed to a nationwide noncompete, among other restrictions, which precluded them from competing with Newmark for two years following the termination of their employment, or alternatively for one year if their departure took place after seven years of service.
In connection with the purchase, the brokers also entered into five-year service agreements which contained noncompetes limited to the brokers' period of service to the company. The purchase agreement was governed by Delaware law.
The brokers worked for Newmark for approximately six-and-a-half years, until May 2021, at which point they notified Newmark of their resignation, along with other members of their sales team.
Newmark quickly filed suit in New York, alleging a premeditated raid, and sought a preliminary injunction which the Supreme Court issued, but not before blue-penciling the restriction down from two years to one year, and narrowing its territorial scope to the state of Colorado.
The brokers appealed to the First Department and argued that, even as narrowed, the noncompete was unenforceable. According to the brokers, while the noncompete in the then-expired service agreements were intended to protect the goodwill they generated while working for Newmark, the noncompete in the purchase agreement was intended to protect only the goodwill that Newmark had acquired from their former company.
As to the latter noncompete, the brokers argued that their six-and-a-half years of service was more than enough time for Newmark to capitalize on the goodwill that it had acquired, and that Newmark lacked any further interest in enforcing a post-termination noncompete.
The First Department disagreed and affirmed the injunction under Delaware law. It found that the noncompete in the purchase agreement is:
- "Reasonable in geographic scope and temporal duration";
- "Advance[s] a legitimate economic interest" of plaintiffs; and
- "Survive[s] a balancing of the equities."
In response to the brokers' challenge to the enforcement of the noncompete after their termination, the court held that:
The two-year temporal duration, which was further reduced by the motion court to one year, is also reasonable — notwithstanding that it did not begin to run until defendants left plaintiffs' employ.
And in response to the brokers' argument that their six-and-a-half years of employment was more than sufficient for Newmark to realize the benefit of the goodwill that it had acquired from their former company, the court disagreed and held that:
The fact that plaintiffs enjoyed the benefits of the goodwill stemming from defendants' continued employment for 6½ years after the purchase of their former company does not mean that plaintiffs did not have a continued legitimate economic interest in protecting that goodwill upon defendants' subsequent departure.
Both the Bruderman and Newmark cases confirm that New York courts will enforce noncompetes in purchase agreements that extend for periods following the seller's departure from the buyer's employ. And in Newmark, the court held that such enforcement was permissible six and a half years after the closing in order to protect the buyer's goodwill.
Reed Mill v. Jensen
In comparison, at least one appellate court in Colorado — the home state of the brokers in Newmark — previously took a different approach on how to deal with a restrictive covenants in the sale of business context.
In the 2006 Reed Mill & Lumber Co. v. Jensen decision,[7] a buyer sought to enforce a noncompete restriction arising from its purchase of a mill and lumber business.
The sale was documented in a purchase agreement that contained a three-year noncompete from closing, and a related noncompete agreement that provided for a three-year restriction upon the seller's termination of employment from the company.
The seller ultimately worked for the buyer for six years after which the buyer sought to enforce the three-year restriction in the noncompete agreement.
According to the buyer, it was reasonable to begin the noncompetition period upon termination of employment because the seller not only possessed goodwill at the time of the sale but "maintained that good will during his employment" with the buyer.
The Colorado Court of Appeals disagreed, finding that the buyer's interest in enforcing the noncompete extended only for the period necessary to:
- "Prevent the former owners from benefiting from the company's good will";
- "[G]ive buyer time to convert that good will to its own"; and
- [D]issipate the extent to which the marketplace identified the company with the former owners."
In analyzing whether seller's six years of employment provided the buyer sufficient time to achieve these goals, the court considered factors such as:
- The seller's percentage of ownership of his former company;
- The nature of seller's employment after purchase;
- The seller's professional experience;
- Whether the seller was in a management or executive position; and
- Any hardship from enforcement.
The court ultimately concluded that six years was sufficient to protect the buyer's investment in the seller's goodwill, and that a further three year post-employment restriction was unreasonable.[8]
Conclusion
Bruderman and Newmark confirm that where the seller or owner of a business goes to work for a buyer following the sale, New York courts will enforce reasonable noncompetes and other restrictive covenants that take effect after the seller's employment terminates. Each accordingly affirmed injunctions enforcing such restrictions.
In Reed Mill & Lumber, the Colorado appellate court declined to enforce such a restriction, after it determined that a six-year period of employment provided sufficient time for the buyer to convert the seller's goodwill to its own.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] The Great Resignation Was Inevitable, Says the Texas A&M Professor Who Coined the Term. Here's What Comes Next. | Barron's (barrons.com).
[2] 2021 was a blowout year for M&A - 2022 could be even bigger (kpmg.us).
[3] How Biden's Proposed Ban On Non-Compete Agreements Would Impact Companies (forbes.com).
[4] Bruderman Bros. LLC v. Goldberg, 193 A.D.3d 478 (1st Dept. 2021)
[5] Newmark Partners LP v. Hunt, 200 A.D.3d 557 (1st Dep't 2021).
[7] Reed Mill & Lumber Co. v. Jensen, 165 P.3d 733 (Colo. Ct. App. 2006).
[8] See also Koeplin v. Milestone Group, Inc. , 2018 WL 4368885, at *4 (D. Colo. 2018) (questioning whether non-compete agreement was reasonable where the employer "had almost six years to cultivate for itself the goodwill that it purchased with the merger" and, "[t]aken to its logical conclusion," the purchaser's argument "would mean that, even if [the employee] had worked twenty years or more for [the purchaser], [the purchaser] could still enforce the covenant").