01 June 2011

New York's Highest Court Clarifies Law Regarding Implied Covenant Not to Solicit Imposed on Sellers of Businesses

Chaya F. Weinberg-Brodt
Special counsel | US

In Bessemer Trust Co. v. Branin, __ N.Y.3d __, 2011 N.Y. LEXIS 602 (April 28, 2011), the New York State Court of Appeals reiterated that absent an express post-sale restrictive covenant, a seller of a business may open a competing venture and accept the patronage of former clients who choose to follow her, as long as she does not actively solicit those clients.  The Court of Appeals refused to create a “hard and fast rule” about what does, or does not, cross the line to improper active solicitation, although it gave some guidelines discussed below.  Bessemer __ thus clarifies that while the “implied covenant,” imposed on a seller of a business not to solicit former clients is perpetual in time, it is somewhat limited in scope.  For this reason, a buyer of a business who seeks more protection than that which is afforded by Bessemer __ is advised to heed the Court of Appeals’ advice, and obtain an express post-sale restrictive covenant.

The implied covenant prohibits a seller of a business from soliciting former clients, and it is imposed by operation of law as described in Mohawk Maint. Co. v. Kessler, 52 N.Y.2d 276, 285-86 (1981) (“the law imposes upon the seller a specific duty to refrain from soliciting his former customers after he has sold his business and the accompanying ‘good will’ to another,” even absent an express restrictive covenant).  This implied covenant lasts forever, and is tied to the seller’s “implied promise” to try to transfer the loyalties of existing customers to the buyer.  __

However, Mohawk carved out an important limitation, stating that a seller is free to open a competing venture, and accept the patronage of former customers who seek to shift their business without the seller’s prompting.  A buyer who seeks protection from this scenario can get it only with an express restrictive covenant. 

With this as backdrop, Bessemer does not necessarily narrow the “Mohawk doctrine,” but it nevertheless shows that the New York courts will probably not expand the doctrine beyond the letter of specific conduct (which the Court of Appeals refused to define) which amounts to active solicitation.  However, a seller who stays within the letter of these rules will likely not be found liable for violating their spirit – even if the seller takes deliberate, successful steps, short of “active solicitation” to cause most of her former clients to transfer their allegiance. 

In Bessemer, defendant Branin sold an investment management business to plaintiff Bessemer, and became an employee.  Branin soon became dissatisfied, and joined a competitor.  As stated in the opinion of the United States Court of Appeals for the Second Circuit (which certified the case to the New York State Court of Appeals), Branin joined this competitor intending that the bulk of his clients would follow him, and the competitor crafted and implemented a strategy to entice those clients to do so.  See Bessemer Trust Co. v. Branin, 618 F.3d 76, 82 (2d Cir. 2010).

However, Branin also took steps to avoid crossing the line to “active solicitation.”  He did not initiate contact with his former clients, but instead waited until they called him.  When clients did contact him to ask why he moved, Branin stated that the new business was a better fit for himself, without stating whether it would be a better fit for the clients or disparaging Bessemer.  When clients sought information about his new firm, he provided it.  When a major client asked for a meeting to decide whether to transition its accounts, Branin helped plan for the meeting, and provided background information about the client, including its investment philosophy.  However, although Branin participated in the meeting, his role was limited to introducing the participants and to occasionally amplifying points made by others. Thereafter, however, at the client’s request, Branin traveled to the client’s home to describe how the account would be handled and the fee structure.  The next day, the client moved its accounts. 

The federal district court, on these facts, found that Branin “solicited” only the client he met with, but not the other clients who also shifted their business.  The Second Circuit found the issue to be in doubt, and certified to the New York State Court of Appeals the question of what degree of participation in the competitor’s solicitation would violate Mohawk.  Specifically, the Second Circuit questioned whether Branin crossed the line with: (1) active development and participation in response to inquiries from a former client in a plan whereby others would solicit a client, and (2) participation in solicitation meetings where Branin’s role was largely passive.  See Bessemer, __ 618 F.3d at 90.

The Court of Appeals, in answering the certified questions, stated that there was “no hard and fast rule” to determine whether improper solicitation had occurred, and “decline[d] to create one here.”  Bessemer, 2011 N.Y. LEXIS 602, at *7.  However, it did provide some guidelines for use on a case-by-case basis:

(1)  A seller may not initiate contact with former clients, including targeted mailings or individualized telephone calls.  However general advertising to the public is permitted.

(2)  A seller “is not free to tout his new business venture,” even if a customer initiates contact.  A seller may respond to factual questions from former customers about the new competing venture, but the responses may not go beyond the scope of the specific information sought.  Id.

(3)  A seller may not, even if prompted, disparage the business sold, or explain why the products or services of the new business are superior to those of the business sold.

(4)  A seller may convey information about his former clients to his new employer, but he cannot include information that is proprietary to the new owner of the business sold. 

(5)  A seller may assist his new employer in preparing for a “sales pitch” meeting requested by a former client, and may be present during the meeting, but his role in the meeting must be limited to responding to factual matters.

A seller who adheres to the foregoing guidelines may then accept the trade of the former client, if it is offered.  

The case now goes back to the federal courts which will determine whether Branin is liable under the Mohawk/Bessemer doctrine.  At present it is unclear when the federal courts will rule, but this case will continue to be closely watched.  In the interim, a buyer of a business who wants greater or more defined protection should seek express written post-sale covenants.

Chaya F. Weinberg-Brodt Special counsel | New York

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