We have previously written on this blog concerning non-competition agreements in franchising. We also have several pages on our web site devoted to the topic, both in terms of drafting or handling non-competition agreement disputes.
The topic keeps coming up in our practice and we have found that it bears a closer examination. We have researched the current state of the law on drafting and enforcing non-compeition agreements in New York. We’ll give you a brief overview of the law as a whole on these agreements, then focus in a second part on specifically how these agreements are viewed in the franchising context.
Non-competition provisions generally appear in three types of agreements: (i) the sale of a business with accompanying goodwill; (ii) employment agreements; and (iii) other commercial contracts such as franchising or licensing agreements.
Enforcement of a non-competition agreement in the context of a sale of a business rests on the premise that the buyer of the business should be able to prohibit the seller from re-engaging in that business in order to protect the buyer’s investment. See Purchasing Assocs. v. Weitz, 13 N.Y.2d 267 (1963). In cases concerning the enforcement of a non-competition provision in connection with the sale of a business, New York courts have held that the seller will be barred from competing with the buyer and soliciting business from former customers provided that the restrictions are reasonable with respect to time and scope. See Mohawk Maintenance Co., Inc. v. Kessler, 52 N.Y.2d 276 (1981).
Enforcement of non-competition provisions in employment agreements is rigorously examined by courts because enforcement may prevent the employee from earning a livelihood. Historically, courts have been reluctant to enforce non-competition provisions that prevent someone from earning a living. The test for enforcement of a non-competition provision in an employment situation is a three part test: (i) the restriction is no greater than is required to protect the legitimate interests of the employer; (ii) the restriction does not impose an undue hardship on the employee; and (iii) the restriction does not cause injury to the public. See BDO Siedman v. Hirshberg, 93 N.Y.2d 382 (1999). In the employment context, New York courts have recognized that employers have legitimate interests in maintaining their trade secrets and confidential information, preventing unfair competition and protecting their goodwill with clients. Additionally, courts have enforced non-competition provisions where the employee’s services to the employer are unique or extraordinary. See Reed, Roberts Associates, Inc. v. Strauman, 40 N.Y.2d 303 (1976), Columbia Ribbon & Carbon Mfg. Co., Inc. v. A-1-A Corp., 42 N.Y.2d 496 (1977) and Ecolab, Inc. v. Paolo, 753 F.Supp. 1100 (1991).
In the case of other commercial contracts, courts will determine whether or not to enforce a non-competition provision by applying a rule of reason test, which balances the competing public policies of honoring the parties’ freedom to contract and favoring robust competition. The New York court inCarvel Corp. v. DePaola, 2001 WL 528203 analyzed the following three factors in applying the rule of reason test: (i) whether the plaintiff demonstrated a legitimate business interest that warrants enforcement of the non-competition provisions; (ii) the reasonableness of the non-competition provisions with respect to the geographic scope and temporal duration; and (iii) the degree of hardship that enforcing the provisions would inflict upon the defendants.
With respect to a non-competition provision between a franchisor and franchisee, New York courts have enforced non-competition provisions against a franchisee where the franchisor has a legitimate business interest in protecting (i) its trade secrets and confidential information which it provided to the franchisee; (ii) the goodwill generated from customer and referral relationships in the territory in which the franchisee operated; and (iii) the franchisor’s ability to place another franchise in the territory. See ServiceMaster Residential/Commercial Services, L.P. v. Westchester Cleaning Services, Inc., 2001 WL 396520. In cases enforcing non-competition provisions in franchise contexts, New York courts have noted that if the former franchisee was permitted to compete against the franchisor in its former territory, the former franchisee could use the trade secrets and confidential information it acquired while operating as a franchisee as well as the goodwill it developed during that time to unfairly divert business away from the franchisor. See DAR & Assoc. v. Uniforce Servs., Inc., 37 F.Supp.2d 192 (1999).
More on these issues in our next blog.