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Court Issues Injunction Enforcing A Covenant Not To Compete In Connection With The Sale Of A Business

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  • Posted on: Feb 8 2017

The enforceability of a covenant not to compete is an issue that commercial and business lawyers often consider in their practice. Sometimes, the issue arises when an employee leaves a business to open his/her own shop, while other times the issue arises in the sale of a company.  On January 18, 2017, in Shimon v. Paper Enterprises, Inc., 2017 NY Slip Op. 30101(U), Justice Sylvia G. Ash of the Supreme Court, Kings County, Commercial Division, issued an injunction enforcing a covenant not to compete in the latter situation.

Covenant Related to the Sale of a Business vs. Covenant Related to Employment:

Covenant Not to Compete in The Sale of a Business

A covenant not to compete, which relates to the sale of a business and its accompanying good will, is enforceable when it is reasonable in scope and duration and is not unduly burdensome. Mohawk Maintenance Co. v. Kessler, 52 N.Y.2d 276, 283-284 (1981). The purpose of the covenant in this context is to protect the purchaser’s acquisition of goodwill in the going concern. Purchasing Assoc. v. Weitz, 13 N.Y.2d 267, 271 (1963). It does so by preventing the seller from starting a new competing business in which the seller could solicit the business of former customers who would voluntarily follow the seller to the new business. Town Line Repairs, Inc. v Anderson, 90 A.D.2d 517, 517 (2d Dept. 1982). New York courts have applied this “sale of a business” rationale in cases where an owner, partner or major stockholder of a commercial enterprise had sold his/her interest for an immediate consideration which was, in part, payment for the good will of the business, in terms of “continuity of place” and “continuity of name”.  Purchasing Assoc., 13 N.Y.2d at 271.

As noted, a covenant not to compete in the sale of a business is reasonable when it is not broader in terms of time, scope and area than is reasonably necessary to protect the buyer’s interest in the going concern. Purchasing Assoc., 13 N.Y.2d at 271. Three to five year restrictions have generally been held to be reasonable. See, e.g., Hakakian v. Think Bronze, LLC, 2010 N.Y. Misc. LEXIS 6513; 2010 NY Slip Op 33597(U), *7 (Nassau Cty. Sup. Ct. 2010) (citing FTI Consulting Inc. v. Price Waterhouse Coopers, LLP, 8 A.D.3d 145 (1st Dept. 2004)). Whether a covenant is reasonable depends on the circumstances of each case. Karpinski v. Ingrasci, 28 N.Y.2d 45, 49 (1971).

A covenant not to compete will not be declared invalid merely because it is unlimited in duration if the other restrictions on geographic area and scope are limited and reasonable. Thus, if a particular restriction is considered unreasonable, it can be severed and the covenant in its modified form can be enforced. Karpinski, 28 N.Y.2d at 51.

Covenant Not to Compete in Employment

Covenants not to compete pursuant to the sale of a business are not treated as strictly as those whose sole purpose is to limit employment. In the employement context, a restrictive covenant will only be subject to enforcement to the extent that it is reasonable in time and area, necessary to protect the employer’s legitimate interests, not harmful to the general public and not unreasonably burdensome to the employee. Courts in New York generally disfavor these covenants because they inhibit a “man’s livelihood” (Purchasing Assoc., 13 N.Y.2d at 272), as well as the flow of services, talent and ideas.

The courts have determined that employers have a legitimate interest in safeguarding the information and ideas that made the business successful and protecting against commercial piracy. Id. at 274. Thus, covenants not to compete are enforceable only to the extent necessary to prevent the disclosure or use of trade secrets or confidential customer information. However, where the employee’s services are deemed “special, unique or extraordinary”, then the covenant, even if reasonable, may be enforced by injunctive relief though the employment did not involve the possession of trade secrets or confidential customer lists.

Shimon v. Paper Enterprises, Inc.:

Background

The action arose from the purchase of Worldwide Sales & Distributing, Inc. (“WSD”) by Paper Enterprises, Inc. (“PEI”). In connection with the transaction, the parties entered into three agreements: (1) the Asset Purchase Agreement by which PEI purchased certain WSD assets and assumed certain liabilities; (2) the Employment Agreement by which PEI agreed to employ the plaintiff, Barry Shimon (the former owner of WSD), as manager of PEI’s newly formed “Retail Division” for a term of five years; and (3) the Warehousing and Services Agreement by which WSD agreed to allow PEI to store, warehouse, assemble and repackage its merchandise at WSD’s warehouse in Edison, New Jersey.

The Asset Purchase Agreement contained a non-compete clause stating, in relevant part, that Shimon agreed that “for a period of five (5) years from and after the Closing Date … he will not engage in any business similar to or which competes with the Business anywhere in the states of New York, New Jersey, Pennsylvania, Connecticut, Maryland and Delaware, directly or indirectly ….”

After two years, Shimon left PEI’s employ and formed a new company in New York called “Great $ Deal Inc. (“Great Deal”). Great Deal competes with PEI.

Shimon sought a preliminary injunction to prohibit PEI “from taking any action that would prevent, inhibit and/or otherwise impede [his] ability to obtain employment and/or engage in commerce in order to support himself and his family.” Shimon claimed that PEI breached the three agreements discussed above, thereby relieving him of his performance obligations. In addition, Shimon argued that the non-compete clause was unenforceable because it was overbroad – that is, the five-year restrictive covenant contained in the Asset Purchase Agreement was unreasonable in light of the two-year restrictive covenant contained in the Employment Agreement.

PEI also sought a preliminary injunction.  PEI sought to enjoin Shimon from soliciting or attempting to pursue, market or solicit the business of any PEI customers or prospective customers for a five-year period beginning with date of the transaction closing.

The Court’s Decision

Justice Ash denied Shimon’s motion and granted PEI’s cross-motion only to the extent that Shimon, either directly or indirectly, individually or through any person or entity, was prohibited from soliciting or attempting to pursue, market or solicit the business of any of PEI customers or prospective customers until August 27, 2017 (five years after the deal closed). In so ruling, the Court found:

Here, given the undisputed facts, the Court finds that PEI has established entitlement to the injunctive relief that it seeks. First, Shimon’s contention that he is not bound by the Asset Purchase Agreement is without legal support and is otherwise without merit. Secondly, Shimon fails to provide support for his argument that the geographic scope or duration of the subject restrictive covenant is overly broad. He fails to dispute that PEI’s business extends into the six-state Territory. Accordingly, there is no basis to deem the subject restrictive covenant unenforceable. Conversely, Shimon’s application for injunctive relief must fail.

Takeaway:

Shimon is instructive for two reasons.  First, it demonstrates the ease with which the courts will enforce a covenant not to compete related the sale of a business. Second, it underscores the requirement that the covenant must be reasonable in scope, time and geographic location.

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