New Jersey Non-Compete Agreements and Employee Duty of Loyalty Examined by Appellate Division

 

New Jersey law imposes certain requirements on the behavior of employees, whether through the common law or contract.  New Jersey employment law and business law will enforce restrictive covenants, including non-compete agreements, if they meet certain requirements.  However, the tests for enforceability are different for restrictive covenants contained in employment agreements and those  which are part of the sale of a business.  Likewise, whether or not there are restrictive covenants, New Jersey employment law imposes on employees a duty of loyalty to their employers.  The Appellate Division recently examined these requirements.

 

Background

Robert Ryerson was a registered investment advisor (RIA), providing financial planning and investment services until the National Association of Securities Dealers (NASD) found him guilty of misconduct in 2006 by sharing commissions with non-NASD members and intentionally misleading his employer.  Ryerson owned and operated NCP, a small financial advisory firm.  However, the NASD’s revocation of his license meant he could no longer operate NCP.

Murray Woloshin was also an experienced RIA and insurance agent, providing financial planning and investment services.  Woloshin purchased all of NCP’s assets through a company he started for the purpose, NCCM.  The New Jersey Bureau of Securities approved the transaction.  Woloshin paid Ryerson $250,000 for NCP, which could be increased to $750,000 if the company hit certain metrics.  Payment was to be made over four years.

As part of the sale, Ryerson agreed to a  consulting agreements.  Part of the consulting agreement provided that:

all NCCM client data was and would remain proprietary to NCCM during and subsequent to any termination of Ryerson’s employment and forever thereafter, even if he introduced clients to NCCM. Additionally, Ryerson agree[d] not to use, communicate, reveal, or otherwise make available any confidential client information except solely and exclusively in furtherance of [his] employment with NCCM. Ryerson was also prohibited from removing any records from company offices without express permission.

The Consulting Agreement also required Ryerson to maintain the confidentiality and privacy of all NCCM client information. Ryerson also agreed not to: discard, delete, alter or modify any correspondence (hard copy or electronic) sent or received by you as a Consultant of [NCCM] unless in accordance with [NCCM]’s policies and procedures[; or]… solicit clients or prospective clients of [NCCM] for any purpose, including to modify or terminate their relationship with [NCCM], or to become clients of some other company or entity that competes in any way with [NCCM], nor to sell them any products or services, nor cooperate in any way with any third-party in the sale of products or services, that might in any broad sense compete with [NCCM].

These restrictions were to stay in place for one year after the later of the final payment or the end of Ryerson acting as a consultant for NCCM.

They also signed a Confidentiality and Restrictive Covenant Agreement, which provided that all confidential information about clients would forever stay NCCM’s property, regardless of whether or not Ryerson brought the clients in, and that Ryerson would not use NCCM’s documents and information  except in his employment or remove it from NCCM’s office.

It also contained a non-competition agreement which provided that:

(i) any person or entity who is a[n] [NCCM] client… at the inception of [Ryerson’s] employment/association, or becomes a[n] [NCCM] client… during the term of [Ryerson’s] employment/association… or (ii) any person or entity identified as a prospective [NCCM] client (i.e., any and all individuals or entities identified and/or contacted by [or who contacts] the Company for the purpose of becoming a[n] [NCCM] client within the [twenty-four] month period prior to the termination of [Ryerson’s] employment/association).

The non-compete agreement lasted  for two years after Ryerson’s employment with NCCM ended for any reason.  After signing the agreements, Ryerson remained working for Woloshin at NCCM for eight years.

In 2015, Ryerson developed a plan to steer clients away from NCCM and disparaged Woloshin.  Ryerson recruited Louis Terrero to become part of the plan since Ryerson’s license was terminated.   Ryerson and Terrero formed Applewood Asset Management, LLC for Terrero to provide the services that Ryerson was not allowed to provide himself.  Ryerson took NCCM’s original files, had an outside vendor download NCCM’s data and upload it to the cloud, and had Terrero begin copying NCCM documents, including client lists and personal information.  Ryerson and Terrero solicited NCCM’s clients.

Woloshin and NCCM went to court and obtained a temporary restraining order, which Ryerson and Terero repeatedly violated.

A trial was held, at which Woloshin testified that virtually all of NCCM’s clients were taken by Ryerson.

A bench trial was held in the Chancery Division of the Superior Court of New Jersey in Essex County.  The trial judge found for NCCM and Woloshin, and awarded them $226,404.26 in compensatory damages, $17,559.25 in prejudgment interest, and $227,069.81 in attorneys fees which were provided for in the agreements.

 

Ryerson’s Appeal

Ryerson appealed to the Appellate Division of the Superior Court of New Jersey.  His main argument was that the restrictive covenants should not be enforced.  The Appellate Division rejected his argument.

 

The Appellate Division Examines Non-Compete Agreements

The Appellate Division explained that “Non-competition covenants, while enforceable, are scrutinized closely because they operate in derogation of free competition and the individual’s right to exploit his or her skills and labor.”  However, different standards apply to different types of non-compete agreements.

Non-compete agreements signed as a condition of employment are more strictly scrutinized, and are enforced “only insofar as they are reasonable under the circumstances.”  Toward that end, courts have explained that the covenant’s purpose cannot be merely to limit the employee’s ability to work, but can only serve to protect the employer’s legitimate business interests, such as preventing an employee from using his position to poach clients or other employees with her when she leaves.  Even then, the agreement  may be limited (or “blue penciled”) by a court to ensure that the terms are reasonable “in terms of the geographical area, period of enforceability, and scope of prohibited activity.”

Restrictive covenants entered into by a seller as part of the sale of a business are much more strictly enforced, however.  The Appellate Division explained:

In contrast to restrictive covenants ancillary to an employment agreement, covenants ancillary to the sale of a business are accorded far more latitude.  Sound reasons explain the difference in treatment: [I]f a retail store is purchased at a particular location, the seller receives payment for the good will generated at that location, recognizing that customers would be inclined to continue shopping at the facility. For the seller to thereafter trade on that good will by reopening within the competitive area would destroy the essence of the transaction.

[N]oncompetitive agreements… have a proper place and are enforceable under appropriate circumstances. Thus[,] a seller’s incidental noncompetitive covenant, which is designed to protect the good will of the business for the buyer, is freely enforceable in the courts.

Given that the restrictive covenants in question were made in the course of the sale of Ryerson’s business to Woloshin—for which he had been paid hundreds of thousands of dollars—and that the terms were narrowly crafted to meet NCCM’s ‘reasonable needs, the court found that they were enforceable and that Ryerson had clearly violated them.

 

The Appellate Division Explains the Duty of Loyalty

Beyond the enforcement of the restrictive covenant, the Appellate Division explained that Ryerson violated his duty of loyalty to his employer under New Jersey employment law.

An employee’s duty of loyalty to his or her employer goes beyond refraining from privately soliciting the employer’s customers while still employed. The duty of loyalty prohibits the employee from taking affirmative steps to injure the employer’s business.  An employee has a specific duty not to compete with his or her current employer.  Four factors determine whether an employee-agent breached the duty of loyalty:

1) the existence of contractual provisions relevant to the employee’s actions; 2) the employer’s knowledge of, or agreement to, the employee’s actions; 3) the status of the employee and his or her relationship to the employer, e.g., corporate officer or director versus production line worker; and 4) the nature of the employee’s [conduct] and its effect on the employer.

Applying Ryerson’s actions to this test, the Appellate Division had no problem finding that he clearly violated his duty.

 

The Takeaways

• If you are a seller selling a business in New Jersey, part of what you have been paid for bu the buyer is the good will that you have built up in the business. Part of that is the business’s clients and employees.  If you agreed not to compete after you got paid for the sale, and the restrictions don’t keep you from earning a living in some way, they will probably be enforced.
• Restrictive covenants in employment contracts are examined much more closely, but if they are not unreasonable in time, geography and scope, they will be enforced as well.
• Employees owe a duty of loyalty to their employers. This doesn’t  mean they have to take a bullet for their employers; but it does mean that they can’t do anything to harm their business while they’re working for it.

 

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