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Ex-Employees' Fiduciary Duty to Their Employers

New York

,

United States of America

Issue

In the absence of a non-compete agreement, what are the parameters, if any, of a former executive and director’s obligation not to compete with the corporation?

Conclusion

In the absence of an express agreement not to compete, ex-employees may engage in fair and open competition with their former employers. (Pearlgreen Corp. v. Chu, Innoviant Pharmacy, Inc. v. Morganstern, Leo Silfen, Inc. v. Cream)

Courts will not imply anti-competitive covenants covering the post-employment period. (American Broadcasting Companies, Inc. v. Wolf)

Directors and officers of a corporation owe fiduciary duties to the corporation that they serve. (Long Island Family Medical Group v. Zimmerly)

No New York decisions were identified in which it was alleged that a former officer or director had breached their fiduciary duties by competing against the corporation in the absence of a non-compete agreement.

However, an employee's fiduciary duty to their employer, if such a duty exists, may continue after termination of the employment relationship. (American Federal Group, Ltd. v. Rothenberg, Exec. Trim Constr. v. Gross)

A former employee may have a fiduciary duty to refrain from: a) diverting business in which a former employer has a tangible expectancy; b) using information obtained during the employment that was confidential or that was available to the fiduciary only because of the employment; and, c) and soliciting a former employer's customers using information that was taken or copied from the former employer. (American Federal Group, Ltd. v. Rothenberg, Exec. Trim Constr. v. Gross)

Law

In Leo Silfen, Inc. v. Cream, 29 N.Y.2d 387, 328 N.Y.S.2d 423, 278 N.E.2d 636 (N.Y. 1972), the New York Court of Appeals held that in the absence of an express agreement not to compete, ex-employees may engage in fair and open competition with their former employers (at 430):

In the absence of express agreement to that effect between the parties, or a demonstration that a customer list has the several attributes of a trade secret, courts, without more, should not enjoin an ex-employee from engaging in fair and open competition with his former employer. The limiting effects upon the former employee with respect to his ability to earn a living are marked and obvious. (Cf. Purchasing Assoc. v. Weitz, 13 N.Y.2d 267, 272, 246 N.Y.S.2d 600, 603, 196 N.E.2d 245, 247; Paramount Pad Co. v. Baumrind, 4 N.Y.2d 393, 175 N.Y.S.2d 809, 151 N.E.2d 609.) Moreover, the issuance of the permanent injunction in the present case has an untoward consequence. By discharging Cream plaintiffs obtained greater protection than they would have had under their agreement with him, if he had terminated the employment. It was observed earlier that the 1965 employment agreement provided that Cream would not solicit plaintiffs' customers for one year following his termination of the employment. This provision suggests that the parties considered Cream's role as a future competitor, and, more important, were satisfied to provide protection for only one year.

The United States District Court, Northern District of New York, referring to New York law, expanded on the same principles in Innoviant Pharmacy, Inc. v. Morganstern, 390 F.Supp.2d 179 (N.D. N.Y. 2005) (at 194):

Absent a written agreement precluding or restricting such activities, New York law does not prohibit an employee from engaging in head to head competition with a former employer, provided that the employee does not unfairly compete such as through the use of proprietary information misappropriated from the former employer. Leo Silfen, Inc. v. Cream, 29 N.Y.2d 387, 395, 278 N.E.2d 636, 641, 328 N.Y.S.2d 423, 430 (1972); Rick J. Jarvis Assocs. Inc. v. Stotler, 216 A.D.2d 649, 649-51, 627 N.Y.S.2d 810, 811-12 (3d Dep't 1995). The New York law of unfair competition does, however, prohibit the unauthorized taking and exploitation of internal, proprietary information to assist an employee in competing with a former employer. McSpadden v. Caron, No. 03-CV-6285, 2004 WL 2108394, at *17 (W.D.N.Y. Sept. 20, 2004). The misappropriation of detailed internal customer information, as is alleged by the plaintiff in this case, can give rise to a claim of unfair competition and, in the event of the finding of irreparable harm, injunctive relief. Id.

In Pearlgreen Corp. v. Chu, 8 A.D.3d 460, 778 N.Y.S.2d 516, 2004 NY Slip Op 5221 (N.Y. App. Div. 2004), the Appellate Division of the Supreme Court, Second Department reiterated that in the absence of a restrictive covenant, an employee may freely compete with a former employer unless trade secrets are involved or fraudulent methods are employed (at 461):

Contrary to the plaintiff's contention, it did not demonstrate that the defendants were bound by a nonsolicitation agreement. In the absence of a restrictive covenant, an employee may freely compete with a former employer "unless trade secrets are involved or fraudulent methods are employed" (Walter Karl, Inc. v Wood, 137 AD2d 22, 27 [1988]; see Starlight Limousine Serv. v Cucinella, 275 AD2d 704, 705 [2000]; NCN Co. v Cavanagh, supra). The plaintiff's allegations that certain customer information constituted trade secrets and that the defendants misappropriated or copied customer lists were refuted by the defendants. Given the sharply disputed issues of fact, the plaintiff was not entitled to a preliminary injunction (see NCN Co. v Cavanagh, supra; Walter Karl, Inc. v Wood, supra; Zurich Depository Corp. v Gilenson, 121 AD2d 443 [1986]).

In American Broadcasting Companies, Inc. v. Wolf, 438 N.Y.S.2d 482, 52 N.Y.2d 394, 420 N.E.2d 363 (N.Y. 1981), the New York Court of Appeals held that courts will not imply anti-competitive covenants covering the post-employment period (at 488):

Equally unavailing is ABC's request that the court create a noncompetitive covenant by implication. Although in a proper case an implied-in-fact covenant not to compete for the term of employment may be found to exist, anticompetitive covenants covering the postemployment period will not be implied.9 Indeed, even an express covenant will be scrutinized and enforced only in accordance with established principles.

9 Of course, as discussed, tortious interference with the employer's business by a former employee may sometimes be enjoined absent a noncompetitive covenant.

In Long Island Family Medical Group v. Zimmerly, 2009 NY Slip Op 31326(U) (N.Y. Sup. Ct. 6/12/2009), 2009 NY Slip Op 31326 (N.Y. Sup. Ct. 2009), the Suffolk County Supreme Court, citing the New York Court of Appeals in Schwartz v. Marien, 37 N.Y.2d 487, 373 N.Y.S.2d 122, 335 N.E.2d 334 (N.Y. 1975), noted that directors and officers of a corporation owe fiduciary duties to the corporation that they serve (at 4):

It cannot be disputed that the directors and officers of a corporation occupy a fiduciary relationship both to the shareholders and to the corporation that they (Schwartz v. Marien, 37 N.Y.2d 487, 373 N.Y.S.2d 122, 335 N.E.2d 334). Directors and officers have this relationship by virtue of their responsibility to act as guardians of the corporate interests (see, Alpert v. 28 Williams Street Corp., 63 N.Y.2d 557, 483 N.Y.S.2d 667, 473 N.E.2d 19). They may not exercise authority to conduct the business of the corporation in violation of those fiduciary duties owed to the corporation. This fiduciary duty arises because when a director or officer benefits himself or herself at the expense of the corporation, the duty to the shareholders is breached because the shareholders are prevented from realizing their expectation to share fairly in the corporate profits. The directors and majority shareholders of a corporation have an obligation to all shareholders to adhere to fiduciary standards of conduct and to exercise their responsibilities in good faith when undertaking any corporate action, including a merger.

In American Federal Group, Ltd. v. Rothenberg, 136 F.3d 897 (2nd Cir. 1998), the United States Court of Appeals, Second Circuit noted that, under New York law, officers and directors are under a duty to deal fairly, in good faith, and with loyalty to the corporation and other shareholders. The scope of this fundamental duty is determined by the circumstances of each case. Merely taking steps that do not involve the dereliction of positive duties to a current employer in preparation for engaging in competition with that employer after leaving its employ may not involve any breach of fiduciary duty (at 905-906):

Addressing the breach of fiduciary duty claim, the magistrate judge first accurately identified the controlling legal principles under New York law. We summarize them here as the controlling principles for our application in review.

First, and fundamentally, one who, like Rothenberg, is a shareholder, officer and director of a closely held corporation, is under a duty "to deal fairly, in good faith, and with loyalty" to the corporation and other shareholders. See, e.g., Benson v. RMJ Sec. Corp., 683 F.Supp. 359, 375 (S.D.N.Y.1988). This requires that he exert his best efforts in behalf of the corporation and not compete with it or profit at its expense, or place his private interests in conflict with its. See Ability Search, Inc. v. Lawson, 556 F.Supp. 9, 15 (S.D.N.Y.1981), aff'd, 697 F.2d 287 (2d

Page 906

Cir.1982). The scope of this fundamental duty is determined, however, by the circumstances of each case, and does not run to every act having any semblance of employee self-interest. See Burg v. Horn, 380 F.2d 897, 900 (2d Cir.1967). Thus, merely taking steps not involving any dereliction of positive duties to a current employer in preparation for engaging in competition with that employer after leaving its employ may not involve any breach of fiduciary duty. See, e.g., Abraham Zion Corp. v. Lebow, 593 F.Supp. 551, 571 (S.D.N.Y.1984) (filing for and obtaining trademark registration), aff'd, 761 F.2d 93 (2d Cir.1985); Schneider Leasing Plus, Inc. v. Stallone, 172 A.D.2d 739, 741, 569 N.Y.S.2d 126, 128 (1991) (incorporating later competing business). One, however, clearly crosses the line by going further in preparatory steps by actively soliciting the customers of his current employer and diverting his current employer's business to himself. See, e.g., AGA Aktiebolag v. ABA Optical Corp., 441 F.Supp. 747, 754 (E.D.N.Y.1977).

The Court also noted that an employee may not utilize information obtained in a fiduciary capacity to appropriate a business opportunity. This duty does not cease when a fiduciary employee leaves their corporate employment. Former employees may not misappropriate and utilize confidential information (at 906):

Further, the corporate opportunity doctrine prohibits a corporate employee from utilizing information obtained in a fiduciary capacity to appropriate a business opportunity belonging to the corporation. See, e.g., Alexander & Alexander, Inc. v. Fritzen, 147 A.D.2d 241, 246, 542 N.Y.S.2d 530, 533 (1989). And, this doctrine applies even after one owing fiduciary duties leaves his corporate employment. See Abbott Redmont Thinlite Corp. v. Redmont, 475 F.2d 85, 88 (2d Cir.1973). The doctrine's application is limited, however, to business opportunities in which a corporation has a "tangible expectancy" which means "something much less tenable than ownership, but, on the other hand, more certain than a desire or a hope." Alexander, 147 A.D.2d at 247-48, 542 N.Y.S.2d at 534 (quotation omitted).

Finally, even former employees may not misappropriate and utilize confidential information, such as customer lists and other confidential information not generally known to the public, but available only to employees in their endeavors for the company. See, e.g., Abraham Zion Corp., 593 F.Supp. at 569-70

No New York decisions were identified in which it was alleged that a former officer or director had breached their fiduciary duties by competing against the corporation in the absence of a non-compete agreement.

However, in Exec. Trim Constr. v. Gross, 1:20-cv-544 (MAD/DJS) (N.D.N.Y. 2021) the United States District Court for the Northern District of New York stated that, under New York law, an employee's fiduciary duty to the employer may continue after termination of the employment relationship. This duty may include requiring the employee to refrain from: a) diverting business in which a former employer has a tangible expectancy; b) using information obtained during the employment that was confidential or that was available to the fiduciary only because of the employment; and, c) and soliciting a former employer's customers using information that was taken or copied from the former employer (at 21-22):

"Under New York law, an employee owes a duty of good faith and loyalty to his employer." Design Strategies, Inc. v. Davis, 384 F. Supp. 2d 649, 659 (S.D.N.Y. 2005), aff'd, 469 F.3d 284 (2d Cir. 2006). The employee's fiduciary duty to the employer "may continue after termination of the employment relationship." Am. Fed. Grp., Ltd. v. Rothenberg, 136 F.3d 897, 914 (2d Cir. 1998). "Such a continuing duty may, in appropriate circumstances, include the

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specific duty not to divert business in which a former employer has the requisite 'tangible expectancy,' ... and the duty not to exploit to the former employer's detriment specific information obtained during the employment that was either technically confidential or that was available to the fiduciary only because of the employment." Id. (internal quotation and other citation omitted). Moreover, the Second Circuit has suggested that soliciting a former employer's customers using information that was taken or copied from the former employer could constitute "an egregious breach of trust and confidence." N. Atl. Instruments v. Haber, 188 F.3d 38, 47 (2d Cir. 1999) (quoting Leo Silfen, Inc. v. Cream, 29 N.Y.2d 387, 328 N.Y.S.2d 423, 278 N.E.2d 636, 639 (1972)).

Alexsei publishing date:
2021-12-28 17:31:00.777663
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