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New York's Highest Court to Decide Limits on Solicitation of Former Clients by Business Seller

  • August 27, 2010

New York courts have long held that a seller of the good will of a business cannot solicit former clients and thus deprive the buyer of the value of the bargain. The United States Court of Appeals for the Second Circuit now has asked the New York Court of Appeals, the state's highest court, to explain the limits on what a seller may do in furtherance of his new enterprise to gain back former clients for that enterprise after having sold his business. Bessemer Trust Co., N.A. v. Branin, Nos. 08-2462, 08-2677, 2010 U.S. App. LEXIS 17662 (2d Cir. Aug. 24, 2010). The New York court is asked the following question:

 

What degree of participation in a new employer's solicitation of a former employer's client by a voluntary seller of that client's good will constitutes improper solicitation? We are particularly interested in how the following two sets of circumstances influence this analysis: (1) the active development and participation by the seller, in response to inquiries from a former client whose good will the seller has voluntarily sold to third party, in a plan whereby others at the seller's new company solicit the client, and (2) participation by the seller in solicitation meetings where the seller's role is largely passive.

The Facts

The defendant, Francis Branin, Jr., was one of eight principals in an investment management firm. He sold the firm's assets, including its client accounts and related good will, for more than $75 million to the plaintiff, Bessemer Trust Company, N.A., and became an at-will employee of Bessemer. Unsatisfied with the amount of his bonus and his role, Branin subsequently left Bessemer and joined a competitor, Stein Roe Investment Counsel LLC. There, he devised a focused strategy to enable Stein Roe representatives to get Branin's former clients to move their business from Bessemer to Stein Roe. Branin participated in at least two in-person meetings with one major client, but he did not contact any of his former clients directly; he merely responded to their inquiries. When Branin proved successful in drawing many of his former clients from Bessemer, Bessemer sued him. 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." He was ordered to pay $826,335 in damages to Bessemer, an amount determined by the fair market value - measured at the time of the sale - of the client account that Branin wrongfully diverted.

Mohawk Doctrine

The Mohawk doctrine was established in two New York case law precedents, Von Bremen v. MacMonnies, 200 N.Y. 41, 93 N.E. 186 (1910), and Mohawk Maintenance Co. v. Kessler, 52 N.Y.2d 276, 419 N.E.2d 324, 437 N.Y.S.2d 646 (1981). It 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. New York law imposes a limited implied covenant on the seller to refrain from such solicitation. However, he may accept the business of his former clients if they choose to follow him to a new employer. The Second Circuit recognized that the line between active improper solicitation and passive acceptance is not entirely clear under New York precedents. In determining whether improper solicitation has occurred, it is an open question as to how much weight, if any, should be given to such considerations as whether the seller initiates contact with his former clients, how much bad faith the seller demonstrates in attempting to regain their business, and the extent to which the seller's conduct actually caused the former clients to move their business.

After the New York Court of Appeals clarifies this issue, 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.

Missed Chance

The Second Circuit was seemingly critical of the plaintiff in the case, for failing to have taken measures that might have protected its interests and avoided complex litigation. It observed, "New York law permits several steps Bessemer might have pursued to protect itself …, including non-competition and non-solicitation agreements that could have been, but were not, entered into with the … principals at the time of the sale of the firm to Bessemer."

Bessemer now must wade through a thicket of litigation and legal uncertainty in its attempt to recover the value of the good will for which it paid millions of dollars but failed to secure through employment agreements containing appropriate covenants against post-employment competition and direct or indirect solicitation. Had Branin agreed to such restrictive covenants, Bessemer's road to recovery surely would have been easier.

Jackson Lewis attorneys are available to assist employers in crafting suitable agreements to make it difficult for employees to abscond with the good will of the businesses they have transferred without facing clear and severe consequences.

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