Letter to Governor Hochul in Opposition to Ban on Non-Competition Agreements

REPORT BY THE ANTITRUST AND TRADE REGULATION COMMITTEE, CORPORATION LAW COMMITTEE, AND TRADE SECRETS COMMITTEE

The Honorable Kathy Hochul
Governor of the State of New York
Executive Chamber
New York State Capitol Building
Albany, NY 12224

Re: Opposition to A1278B/S3100A Ban on Non-Competition Agreements

Dear Governor Hochul:

This letter is submitted on behalf of the New York City Bar Association (“City Bar”) to respectfully request that you consider certain critical deficiencies in the above bills (the “Bill”), and either veto the Bill, or require chapter amendments to address these issues.  The Bill as passed goes far beyond the goals that you set for this legislation, and as to which there is widespread agreement, and will do harm in outlawing essentially all non-competition agreements in New York, including agreements that long have been recognized both as beneficial to the New York State economy and as not harming workers.

The Bill as passed potentially jeopardizes and de-values hundreds of businesses in New York, large and small, including businesses involved in well-established estate plans and other sales transactions, where a fully enforceable non-compete from the seller of a business is a critical part of a transaction and a critical factor in the valuation of the business.  The Bill also endangers business goodwill and confidential information in a variety of circumstances, such as the lack of a full carve out for customer nonsolicitation agreements, and in providing unintended and unnecessary relief to highly compensated workers and others who do not lack bargaining power.

Restricting Non-Competes for Low Wage Workers is Beneficial; a Complete Ban is Not

The New York Court of Appeals has been a leader in the non-compete area, closely analyzing non-competition agreements, and scrutinizing and attempting to prevent their misuse.  But the Court of Appeals has also recognized that a non-competition agreement may be enforced “to forestall unfair competition,”[1] and New York courts have recognized several legitimate employer interests which justify enforcement, including the protection of trade secrets and confidential information, customer relationships and goodwill, and protection against irreparable harm where the employee’s services are unique or extraordinary.  In BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 391 (N.Y. 1999), the leading New York case on enforcement of non-competes – in which the Court of Appeals carefully limited the extent to which a non-compete could be enforced – the Court noted:  “Professor [Harlan] Blake, in his seminal article in the Harvard Law Review, explains that the legitimate purpose of an employer in connection with employee restraints is ‘to prevent competitive use, for a time, of information or relationships which pertain peculiarly to the employer and which the employee acquired in the course of employment’ (Blake, op. cit., at 647).”[2]

You have advocated restrictions on non-compete agreements for workers earning less than the median wage in New York State.  This view has widespread support in industry, the public and the bar; but the complete ban found in the Bill has no such support.  Indeed, in 2021, the City Bar’s Trade Secrets Committee issued a report, “Legislating Fairness: Regulating the Use of Noncompetes for Lower-Salary Employees February 2021.”[3]  In that Report, the City Bar recommended legislation that would substantially restrict the use of non-compete agreements for lower-wage employees, while preserving the flexibility of New York’s common law approach, which recognizes important commercial considerations for New York’s economy in enforcing non-competes in other contexts.  The City Bar recommended the enactment of a New York State statute imposing a presumptive prohibition on non-compete agreements for employees whose salaries fall below a statutorily-defined limit.  The presumptive prohibition would be rebuttable, but only when the non-compete is for the protection of the protectable interests recognized under decades of New York cases (e.g., trade secrets, protectable customer relationships, employees possessing unique skills or expertise), and when (1) the employer also agrees to pay the affected employee’s full pro-rated compensation for the duration of any non-competition period; and (2)  the employee was provided with notice, prior to the employee’s agreement to enter into the employment relationship, of any non-compete agreement and of the employer’s intention to enforce the non-compete with respect to the particular position.

The present Bill goes far beyond this more limited, presumptive, rebuttable prohibition and would ban non-competes where they are needed and would be pro-competitive, such as where they protect the goodwill, value and alienability of New York businesses, large and small, without adversely affecting workers.

Other States Have Restricted Non-Compete Agreements for Low-Wage Workers

Many states have been active in scrutinizing non-competes and have restricted enforcement of non-competes against low-wage workers.  Colorado, Illinois, Maine, Maryland, Massachusetts, Nevada, New Hampshire, Oregon, Rhode Island, Virginia, and Washington, as well as the District of Columbia, have limited non-compete agreements for low-wage workers, and otherwise require consideration and notice periods to have a valid noncompete.[4]  Many states also impose reasonableness standards where a noncompete may be used.  For example, currently in New York, a non-compete given in an employment context “…will only be subject to specific enforcement to the extent that it is reasonable in time and area, necessary to protect the employer’s legitimate interests, not harmful to the general public and not unreasonably burdensome to the employee.”[5] Minnesota recently enacted legislation restricting non-compete agreements, which does not have salary cap, but which permits non-competition agreements in connection with sales and dissolution of businesses, and also allows nonsolicitation agreements.[6]

To date, eleven states have imposed wage thresholds or related compensation criteria to limit the use of non-competes with low-wage workers.  The plan originally announced by your administration, to restrict enforcement of non-competes against low-wage workers, is fully consistent with this approach, and would not jeopardize other interests.  The Bill, on the other hand, would set New York on a path with significant risks to the New York economy, a path rejected by many other states after careful consideration of the alternatives.  We submit that the consequences of a full ban have not been adequately considered, and that a full ban goes far beyond what would be protective, helpful and beneficial for New York workers and the New York economy.

The California Experience: California Does Not Impose a Ban on all Non-competes

California is the state perhaps best known for “banning” non-competes, and Section 3 of the Senate and Assembly bills appear to be copied directly from the California statute.[7] But in fact, California’s well-known “ban” is not a total ban, but expressly carves out, and expressly permits the enforcement of, non-competes in connection with the sale of a business and its goodwill, and in analogous situations.[8]

The New York legislature has adopted part of the California statute without addressing key issues covered by that statute, and the result is a Bill that could do substantial damage to business owners, small and large, without providing any further protection for workers. [9]

Non-Competes In Business Sales And Capital Structure Transactions

Non-competition agreements play a critical role in transactions involving the sales of  businesses.  Removing sale of business non-competes from a ban does not harm low-wage workers; however, including such sale of business non-competes within a ban jeopardizes and de-values New York businesses and diminishes their alienability.  When selling owners sell their businesses, it is typical for the parties to protect the goodwill and other assets being sold by entering into unconditional non-compete covenants for a set period of time, often five years, and, if the sellers continue to work for the business post-closing, entering into a second non-compete covenant that continues for a year or two after the selling owners cease to be employed.  This is often done specifically to protect goodwill and to enable the buyer to actually acquire the goodwill of the business, something that many regard as occurring over time.

Parties to sale of business transactions typically identify non-compete covenants early in the negotiations, and this term may be included as a key part of the structure and pricing of the transaction.  Selling owners typically are represented by their own, separate counsel, engaged to negotiate the scope and terms of any transaction, including the non-compete covenants.  The non-compete covenants may be heavily negotiated, and a portion of the consideration that the selling owners receive is in consideration of the non-compete.

This type of non-compete is a critical factor in supporting the value of the business being sold.  This type of non-compete typically applies to a small group of sophisticated people, not to low-wage workers.

There is no rational reason that the value and goodwill preservation function of these unconditional non-compete covenants should be undermined by a Bill designed to protect low income workers.  Sellers of businesses generally are represented by counsel, have real bargaining power, and can negotiate a price that protects their interests.  If the buyer cannot be assured that it is acquiring the goodwill of a business –  because the Bill jeopardizes the enforceability of the non-competition agreements that are part of the transaction – a buyer is unlikely to pay the amounts that current business owners expect from their businesses.  We support the Bill’s central purpose of protecting low wage workers — but there is no reason why the Bill should also include provisions that radically undercut a key aspect of the economy and the value of businesses built through years of effort.

Executives and Other Key Employees

The entry into non-competition covenants by executives and other key employees is often critical to the success of a business, as well as to the success of a merger or sale initiative that is undertaken by the business.  This is true even where the individuals are not equity sellers in a transaction.  These are typically well paid, sophisticated employees, some of whom may have “phantom equity” or other performance compensation.

Unlike low-wage and other workers who may be offered employment and a non-compete on a “take it or leave it” basis, executives and key employees are often represented by counsel and have significant negotiating leverage to protect their interests.  For both an ongoing business, and in a mergers and acquisition context, the owners of a business may have reservations about hiring executives in key positions, and exposing the inner working of their businesses, if the business does not have the protection of a non-compete with those executives.  While some have argued that trade secret law is sufficient to address this situation, the actual experience has been that trade secret litigation is more complicated, longer, more disruptive for both employer and employee, less predictable, and more expensive, than litigation over non-compete contracts.  Banning non-competes will undoubtedly lead to an increase in trade secret litigation, as has been the experience in California.[10]

Suggested Changes to the Bill

In light of the many concerns over the Bill, we respectfully offer the following suggestions:

1. Veto the Bill Pending Further Study and Consideration of the Statutes Enacted in Other Jurisdictions.

For the reasons set forth above, among others, we believe that the provisions of the Bill, and its potential impact in a variety of circumstances, have not been adequately studied and considered.  We believe that the Bill will cause harm in the manner described above.  Accordingly, we respectfully ask that the Bill be vetoed, and that the above and other issues be considered and addressed during the next legislative session.

We believe the goal of protecting low-wage workers can be achieved, without jeopardizing other legitimate concerns.  Indeed, that was the conclusion and recommendation of the City Bar’s Trade Secrets Committee Report referenced above.  We believe that this has not yet been done, warranting further legislative consideration during the next session.

2. Alternatively, Require Chapter Amendments to Address the Concerns Without Vetoing the Bill

In the alternative, we believe the key concerns could be dealt with through Chapter Amendments that will address the problem areas.  We respectfully offer the following recommended amendments:

A. Restrict the Noncompete Ban to Low Wage Workers

If you decline to veto the Bill, we suggest requiring that the legislature amend the Bill to impose a salary cap for any ban on noncompete agreements, as discussed above.  As noted, we believe that the position you have advocated – which provided for restrictions on non-compete agreements for workers earning less than the median wage in New York State – has widespread support in industry, the public and the bar, while the complete ban found in the Bill does not.[11]

There are variations to this approach that might be considered: (1) the approach of the Trade Secrets Committee Report, that non-competes be banned for low wage workers, unless the non-compete is for the protection of the interests recognized under New York case law (e.g., trade secrets, protectable customer relationships, employees possessing unique skills or expertise), and (i) the employer agrees to pay the affected employee’s full pro-rated compensation for the duration of any non-competition period; and (ii)  the employee was provided with notice, prior to the employee entering into the employment relationship, of any existing non-compete agreement and of the employer’s intention to enforce the non-compete with respect to the particular position; or (2) an approach similar to (1) but with a higher, legislatively defined wage limit.

B. Clearly Carve Out Sale of Business Transactions

The Bill does not contain a carve out for sale of business or other merger/acquisition transactions.  For the reasons set forth above, we believe that non-competes agreed to in connection with a sale of business or other merger or reorganization context should be carved out of any non-compete ban.  The sellers, who are typically business founders, owners, key employees and executives, generally do not need the State’s protection; they are typically sophisticated individuals, represented by their own counsel, and able to negotiate what they consider to be an appropriate price or appropriate compensation for any non-compete.  The buyers/acquirers of the businesses, on the other hand, need the protection of non-compete covenants, or the transactions involved will likely be jeopardized or de-valued.

Some have suggested that the language of the Bill, referring to “employer” and “covered individual,” is sufficient to remove sales of businesses from the ban.  We believe that this is unclear and insufficient assurance that sales of businesses are not included.  The Bill should clearly and directly carve out sales of businesses and the mergers and acquisitions context, so that the parties do not need to debate (or litigate over) the issue.[12]

C. Clearly Carve Out High Wage Earners, Key Employees, Executives and Those Governed by the Employee Choice Doctrine

We believe that limiting the ban on non-competes to persons who earn below a legislatively set amount will address the issue of executives, key employees and high wage earners.

If that clarity is not present in the final version of the bill, we believe that there should be a clear carve-out for these employees.

We also believe that the Bill should carve out, and should not interfere with the operation of, restrictive covenants against employees who choose to accept a covenant and benefits under New York’s “Employee Choice Doctrine,” in which receipt of postemployment benefits are conditioned on compliance with a restrictive covenant.

D. Clarify the Carve-Out for Customer Nonsolicitation Agreements, and Better Define the Carve-Out to Make it Consistent with Law and the Protection of Goodwill

Pursuant to its terms, the Bill does not prohibit agreements which bar a former employee from “…solicitation of clients of the employer that the covered individual learned about during employment, provided that such agreement does not otherwise restrict competition in violation of this section.”  Bill, para. 5.

The law in New York has recognized that an agreement restricting, for a period of time, solicitation by former employees of the prior employer’s customers, is far less restrictive than a non-compete, and thus, is more readily enforced.  Typically, such agreements do not restrict an employee from working in their chosen field, or from working in their chosen location, or from working for a direct competitor of their prior employer.

What such agreements do restrict is soliciting or transacting business with the customers of the prior employer.  In many businesses, the sales representative or executive assigned to a customer’s account becomes the “face of the company.”  Caselaw long has recognized that goodwill with the customers is typically maintained at the employer’s expense: employers typically fund the relationship and fund the employee to be the customer’s primary contact.  It has been recognized that, among the legitimate purposes even of a non-competition agreement, is to “…prevent a departing employee from expropriating his employer’s secrets and clientele.”   Newburger, Loeb & Co. v. Gross, 563 F.2d 1057, 1082 (2d Cir. 1977).  An agreement not to solicit a former employer’s clients has repeatedly been recognized as a critical factor in protecting the goodwill of a business.

Given their less restrictive nature, and the fact that an employee subject to a nonsolicitation agreement can still be employed by competitors, most states more readily enforce these agreements, and several states’ new non-compete statutes expressly carve out nonsolicitation agreements from their restrictions.  For example, the statutes adopted in Washington State and Oregon (both statutes are generally regarded as being “employee-friendly”), and the statute in Massachusetts (generally regarded as being neutral), expressly carve out nonsolicitation agreements from their restrictions.[13]

The Bill carves out nonsolicitation of customer agreements, but only to the extent of  customers that the “…covered individual learned about during employment, provided that such agreement does not otherwise restrict competition in violation of this section.”  We submit that this formulation does not adequately recognize the balancing of interests that takes place in the marketplace, and that has been recognized by extensive caselaw, and is too limited.  The “covered individual” could have sold his or her practice to the employer, and thus should be restricted from all customers of whom the individual learned prior to employment.  The goodwill with the customer could be the result of a substantial investment by the employer, over a period of time, even if the employee knew the customer prior to employment.  Or the employee could have known the customer prior to employment, but have been unsuccessful in turning an acquaintance into a customer. Creating further uncertainty is the fact that there is no definition in the Bill of which agreements, “otherwise restrict competition.”

Under the existing Bill, a departing employee could arguably:  solicit customers whom they had before employment, but whose goodwill they sold to the employer on hire; solicit the employer’s customers whom the employee knew about, but never succeeded in selling to, prior to employment; solicit the employer’s customers whom the employee had a marginal relationship with, but had no real good will, prior to employment.  Merely knowing, or knowing of, a customer, is not the same as having a relationship and goodwill with the customer; in sales organizations, employers often spend a lot of money and investment, furthering and maintaining relationships.  Under New York common law, the employer can try to claim protection for customers that were maintained at the employer’s expense during employment.  New York case law, under BDO Seidman and later cases, has carefully attempted to balance the interests associated with “personal clients” of an employee, versus the clients or customers of the employer.  In short, there are a myriad of circumstances which would make it fair to restrict solicitation of a customer, even one that a former employee knew previously, and unfair to prohibit such a restriction.

We believe that agreements providing for nonsolicitation of customers should be carved out of the Bill and the existing language be changed to better reflect relationships in the marketplace, the nature of the goodwill with customers, and to capture the careful balancing of interests in this area, that New York appellate courts have been carefully developing.   Accordingly, we respectfully suggest that customer nonsolicitation agreements be carved out of the restrictions of the Bill, and that the prior employer be allowed to restrict its clientele, subject to an employee showing that the restriction should not apply in specific circumstances.

E. “Covered Individual”

The Bill at proposed section 191-d(d), introduces the term “covered individual.”  The definition is unclear, and this is a term which we have not seen in other legislation.  We are concerned that ambiguous terms create confusion and generate litigation, while not providing adequate notice to employers and employees as to what is or is not covered by the statute.  If the intent in using this term is to incorporate independent contractors or partners or some other category of persons, that should be stated plainly so the merits of such inclusion can be considered, debated, and agreed to or rejected.

During the process of addressing the above issues, other points may arise or result, that may also require amendment.

Conclusion

For the reasons set forth above, we submit that the Bill should be vetoed, and that it be reconsidered during the next legislative session to address the above points, and to consider the experience in other states of recently enacted or amended laws.

In the alternative, we believe that Chapter Amendments to the Bill are required to address the issues.

We stand ready to assist your staff in whatever way would be helpful.

Respectfully,

Yee Wah Chin, Chair
Rachel Webb, Secretary
Antitrust and Trade Regulation Committee     

Trey Muldrow, Chair
Sarah Kaehler, Secretary
Corporation Law Committee

Jeanine Daves, Co-Chair
Abraham Y. Skoff, Co-Chair
Miguel A. Lopez, Secretary
Trade Secrets Committee