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New York Clarifies Scope of Covenant Against Business Seller's Solicitation of Former Clients

  • May 5, 2011

New York’s highest court has ruled that a business seller may solicit and regain former clients for his new employer without incurring liability for improperly soliciting business under certain circumstances.  Bessemer Trust Co., N.A. v. Branin, No. 63, 2011 NY Slip Op. 3307, 2011 N.Y. LEXIS 602 (Apr. 28, 2011). 

The ruling came in response to a question certified from the U.S. Court of Appeals for the Second Circuit.  The decision underscores the importance of utilizing post-employment competition and solicitation agreements to protect the value of a business purchase.  In addressing the standards of liability that apply when a business purchaser fails to utilize such agreements, however, the State Court of Appeals declined to articulate any bright-line rules, instead, adopting a case-by-case evaluation of certain factors, including those relevant to the particular industry.


Background

Under a covenant implied by New York courts, the seller of the good will of a business cannot actively solicit former clients, thus depriving the buyer of the value of the bargain.  The seller, however, may still compete with the buyer in the same business and even accept his former clients’ business if he is not otherwise bound by any express restrictive covenants.

The defendant, Francis Branin, Jr., sold his wealth management and investment advisory firm's assets, including its client accounts and related good will, to the plaintiff, Bessemer Trust Company, N.A.  He later joined a competitor, Stein Roe Investment Counsel LLC.  There, he devised a focused strategy to recapture his former clients’ business, participated in at least two in-person meetings with one major client, and responded to his former clients’ inquiries. 

After a bench trial, the federal district court found Branin liable for improper solicitation of one major client in violation of the common law “Mohawk doctrine.”  That doctrine prohibits, in perpetuity, a voluntary seller of a client's good will from improperly soliciting business from that client after the client's business, including its good will, is transferred to the purchaser.  However, the seller may accept the business of his former clients if they choose to follow him to a new employer.  (For a full recitation of the facts of the case, see New York's Highest Court to Decide Limits on Solicitation of Former Clients by Business Seller.)

Scope of Active Improper Solicitation

The Court of Appeals declined to provide any bright-line rules on when a seller violates the implied covenant not to solicit his former clients.  Instead, it declared that the trier of fact must consider the principles underlying the Mohawk doctrine and the relevant factors within the industry involved.  However, the Court established the following guideposts:

1. Direct Communications.  The seller may not take affirmative steps to communicate directly with his former clients.  If the seller initiates contact with them, he impairs the good will he sold to the buyer.

2. Advertising and Contacts.  The seller may advertise to the public, if his advertisements are general in nature.  However, he may not send targeted mailings or make individualized phone calls to his former clients informing them of his new venture.

3. Providing Information to Clients.  The seller may answer a former client’s factual inquiries about his new venture.  For example, he may provide information about his new employer’s products or strategies for servicing the client’s needs and he may describe the resources, personnel, and fee structure at his new employer.  But the seller may not go beyond the scope of the specific information sought or freely tout his new business venture.

4. Disparagement.  The seller may not disparage the buyer of his business, even if prompted by his former clients.

5. Comparisons.  The seller may not explain why he believes the products or services of his new venture are superior to those offered by the buyer of his business.

6. Providing Client Information to New Employers.  The seller may convey information about his former clients to his new employer (e.g., clients’ preferences and goals) if this is appropriate in the context of the industry.  However, the seller may not supply the buyer’s proprietary information to his new employer.

7. Role in Sales Pitches.  The seller may aid his new employer in preparing for a sales pitch meeting requested by his former clients and be present at the meeting.  But his role in the meeting must be limited to providing responses on factual matters.

Whether the seller has embarked on a solo venture or joined a direct competitor, he may compete with the buyer of his business and accept his former clients’ business if he avoids contacting former clients directly, merely responds to his former clients’ factual inquiries, and plays a largely passive role at any sales-pitch meetings requested by his former clients. 

The case will now return to the Second Circuit for application of these principles and factors to the case.  The Second Circuit also will revisit whether the district court properly calculated Bessemer's damages under a “return of capital” theory, instead of assessing Bessemer's lost profits. 

Lessons Learned

Where possible, a purchaser of a business should require the seller to sign a post-sale or a post-employment non-compete agreement to guard against the possibility that the seller will work for a short time only to leave and have the business follow him, as happened here.  While restrictions implied by law in the context of the sale of a business provide some measure of protection, most purchasers likely would find the limited protection afforded to be insufficient, particularly since the high court has ruled that merely attending a sales-pitch meeting does not violate the implied covenant.

Jackson Lewis attorneys are available to assist employers in crafting agreements that restrict post-employment competition and direct or indirect solicitation.  Use of express covenants can provide greater protection against employees’ attempts to divert business to their own advantage despite having transferred the good will of the business and other assets.

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