Post-Employment Restrictions: 35 Years of Uncertainty
Can an employer in New York terminate one of its employees without cause, for example by layoff or firing, and still enforce contractual restrictions preventing that employee from competing against it? The Court of Appeals has addressed the issue, twice, in the past 35 years. Yet, its decisions have been cryptic. The various Appellate Divisions and federal courts in the Second Circuit have not construed them consistently. For that reason, the rules are different depending on localized jurisdictions, and even then the result is far from certain. Employers seeking to enforce these post-employment restrictions would be wise to understand the landscape before any foray into a potentially unwelcome jurisdiction. That tortuous landscape is described below.
Employee Choice Doctrine
It is well-established that New York disfavors agreements that restrict an employee's ability to compete against his former employer because "powerful considerations of public policy…militate against sanctioning the loss of a man's livelihood."1 To be enforced, such agreements must pass a test of "reasonableness," meaning they are (1) no greater than required to protect the employer's legitimate interests, (2) not unduly harsh on the employee and (3) not injurious to the public.2 Post-employment restrictions on competition typically will be scrutinized for reasonableness by all courts in New York.
However, the dilemma raised by this article—what is the proper framework after a termination without cause?—arises from an important exception to the standard of reasonableness known as the employee choice doctrine. Under that doctrine, an employer may condition payment of certain post-employment benefits on the employee's agreement not to compete. If the employee competes, the conditioned benefits are forfeited. The rationale for not subjecting such agreements to a reasonableness analysis is that there is nothing unreasonable, the courts hold, about giving an employee the option of either abiding by his agreement not to compete or forfeiting post-employment benefits. The employee's ability to choose is central to the exception.
Litigation over the employee choice doctrine has created a judicial split of authority as to the proper analysis after an employer terminates the employment of one of its employees without cause. The confusion arises from language in a 1979 Court of Appeals' decision, Post v. Merrill Lynch, Pierce, Fenner & Smith, which created an exception to the employee choice doctrine, which, as noted, is an exception to the reasonableness standard.
The employee choice doctrine has its origins in a 1951 Court of Appeals' decision, Simons v. Fried. There, the court reviewed the enforceability of a contract that prevented part owners of a furniture enterprise from competing against the enterprise unless they sold their stock. Enforcing the contract, the court observed, "the Frieds have only to dispose of their Simons Company stock in accordance with the contract and they will then be wholly free to engage or invest in any lawful business anywhere."3 The Frieds had a choice. The main pillar of the employee choice doctrine was born.
Enter Post. Merrill Lynch employed Jack Post and his colleague Maney as account executives. Post and Maney participated in the firm's pension and profit-sharing plans. Merrill Lynch conceded for the purposes of the decision that it terminated Post's and Maney's employment involuntarily and without cause. The former employees then commenced employment with a competitor. Merrill Lynch, pursuant to a forfeiture-for-competition provision in its agreements with the employees, forfeited their benefits.
The court took into account that under the Employee Retirement Income Security Act of 1974 (ERISA) there was a strong federal policy against forfeiture of employee benefits. But, most importantly, the court viewed the reason for the employees' termination as central to its conclusion that the forfeiture was improper and that the ordinary principles of the employee choice doctrine did not apply. In so holding, the court made seemingly broad pronouncements:
Acknowledging the tension between the freedom of individuals to contract, and the reluctance to see one barter away his freedom, the State enforces limited restraints on an employee's employment mobility where a mutuality of obligation is freely bargained for by the parties. An essential aspect of that relationship, however, is the employer's continued willingness to employ the party covenanting not to compete. Where the employer terminates the employment relationship without cause, however, his action necessarily destroys the mutuality of obligation on which the covenant rests as well as the employer's ability to impose a forfeiture.4
Thus, at least in the forfeiture-for-competition context, the employee's choice is not only between competing or keeping post-employment benefits, but also whether to stay or leave his or her current employer. But, the sweeping language is not limited to the forfeiture-for-competition context. The court wrote that "[w]here the employer terminates the employment relationship without cause," the employer "destroyed the mutuality of obligation" that would be present in all restraints on an employee's employment mobility "as well as" the ability to impose a forfeiture. This implies that an employer may not enforce any restrictive covenant after a termination without cause. Arguably, the court's broad legal pronouncements were dictum because they were not central to resolving the case that was before it, the validity of a forfeiture-for-competition clause.
The court went on to reason in much more limited language that the specific forfeiture of "the pension benefits earned by [the] former employee" "is unreasonable as a matter of law and cannot stand."
So, what is the rule of Post? In the forfeiture context, are only pension benefits excepted upon a termination without cause? What about the non-forfeiture context? Does the court's sweeping language mean that no restrictions can be enforced by an employer that lets an employee go without cause?