BDO Seidman v. Hirshberg

Citations: 712 N.E.2d 1220; 93 N.Y.2d 382; 690 N.Y.S.2d 854; 1999 N.Y. LEXIS 860

Court: New York Court of Appeals; May 13, 1999; New York; State Supreme Court

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BDO Seidman, a national accounting firm, appeals a decision affirming the dismissal of its complaint against former employee Jeffrey Hirshberg, related to a reimbursement clause in their employment agreement. This clause required Hirshberg to compensate BDO for serving clients from its Buffalo office within 18 months post-employment. The courts below deemed the clause an invalid and unenforceable restrictive covenant. 

Hirshberg had been with BDO since 1984, promoted to manager in 1989, and signed a "Manager's Agreement" acknowledging a fiduciary relationship with the firm. This agreement stipulated that if he served any former BDO client within the specified timeframe, he would owe BDO an amount equal to 1½ times the fees billed to that client in the last fiscal year, payable in five installments. After resigning in October 1993, BDO claimed he served 100 former clients, totaling $138,000 in lost fees, but Hirshberg disputed this, asserting some clients were his personal contacts and that he was not the primary representative for others.

During summary judgment motions, BDO failed to provide evidence of solicitation or misuse of confidential information by Hirshberg. The Supreme Court ruled in favor of Hirshberg, finding the reimbursement clause overly broad and anti-competitive, a conclusion the Appellate Division upheld, declaring the entire agreement invalid. The Manager's Agreement did not prevent Hirshberg from competing for new clients or explicitly prohibit him from serving former BDO clients, but required him to pay for losses incurred by BDO due to client departures within the designated period.

The agreement in question is characterized as an ancillary employee anti-competitive agreement subject to rigorous judicial scrutiny. Historical context indicates that the validity of post-employment restrictive covenants has been adjudicated for nearly 300 years, with a reasonableness standard evolving to balance employer protection against employee and public interests. The modern standard requires that such restraints are reasonable in terms of necessity for protecting the employer's legitimate interests, not imposing undue hardship on the employee, and not being detrimental to the public. In New York, this standard is strictly enforced, particularly limiting broad competitive restraints and recognizing only specific employer interests, such as trade secret protection and unique employee services.

However, in the context of professional agreements, such as those in accountancy, courts have been more lenient in enforcing restrictive covenants, especially when applied within confined geographical areas. Precedents support this leniency, acknowledging the unique skills of professionals. The legal status of accountancy as a learned profession is affirmed, given the extensive training, examination, and continuing education requirements imposed on CPAs, alongside a regulated professional conduct framework. These considerations align with criteria for learned professions and suggest that the restrictive covenant in question may be valid under the established legal standards.

Gelder Medical Group and Karpinski do not determine the outcome in this case. The test of reasonableness for employee restrictive covenants hinges on the specific facts and circumstances surrounding the agreement. Unlike the precedents set in Karpinski and Gelder Medical Group, which involved healthcare professionals in a narrow market, the current case involves BDO, a national accounting firm enforcing a covenant in a broad metropolitan area. The defendant's role was primarily based on his ability to attract corporate clients rather than any unique skills, and there is no evidence that he possessed extraordinary accounting abilities that would give him a competitive edge.

The agreements in Karpinski and Gelder Medical Group were fundamentally different, as they pertained to direct competition for referrals among healthcare providers in rural areas. Thus, prior case law does not exempt the need for thorough examination of the Manager's Agreement's anti-competitive clauses under common-law standards. 

Upon analyzing the covenant's first prong, it appears overbroad. BDO claims it seeks to protect its entire client base, which it argues requires significant investment to maintain. However, an employee may fairly compete for clients without resorting to unfair means, making the employer's interest in protecting its client base less legitimate. Legal experts have more carefully defined the employer's interest in preventing competitive use of specific information or relationships gained during employment. The employer's risk is heightened when an employee works closely with clients, as they may benefit from the goodwill generated by the employer's efforts.

An employer has a legitimate interest in preventing former employees from using client goodwill developed at the employer's expense, particularly in a way that harms the employer's competitive position. In this case, BDO's interest lies in protecting against the defendant's competitive use of client relationships that BDO facilitated through the defendant's accounting services during his employment. However, extending the non-compete clause to clients with whom the defendant did not have a direct service relationship would violate the common-law rule against unnecessary restraints, as it would be overly broad.

Several state courts have invalidated similar restrictive covenants that do not consider whether the employee had direct involvement with the clients during their employment. While some courts have upheld such covenants, they either failed to clearly identify the employer's legitimate interest or did not adequately assess if the restrictions were excessive. As a result, the clause in the Manager's Agreement that requires the defendant to compensate BDO for losses from clients he never served directly is deemed invalid.

Additionally, extending the covenant to the defendant’s personal clients, who sought his services independently and outside BDO's support, would unjustly allow BDO to claim goodwill generated by the defendant. This enforcement would contradict the rationale behind such non-compete agreements. Nevertheless, aside from these overbroad applications, the restrictions in the sixth paragraph of the agreement are reasonable, as they limit the non-compete period to 18 months and apply only to clients from BDO's Buffalo office. This duration is deemed sufficient for BDO to recover its client relationships. The defendant remains free to pursue new business opportunities and retain his personal clients and those he had minimal involvement with at BDO.

BDO's list of lost accounts includes clients from both categories, indicating limited evidence that the covenant, if adjusted for overbreadth, would impose undue hardship on the defendant. The variety of accounting services in the Buffalo area and the small number of affected BDO clients suggest that a narrowed covenant would not significantly restrict the availability of accounting services or create market dislocation or monopolistic conditions. Consequently, this supports the conclusion that a reformed covenant would not violate public interest standards. 

The Appellate Division incorrectly determined that the entire covenant must be invalidated, rather than allowing for partial enforcement to protect BDO's legitimate interests. Previous case law, such as Karpinski v Ingrasci, allows for judicial severance and enforcement of only the reasonable parts of an overbroad restrictive covenant. 

The modern legal perspective favors a case-specific analysis rather than a blanket invalidation of overbroad agreements, especially when the unenforceable portion is not central to the contract. If the employer demonstrates good faith and absence of coercive behavior, partial enforcement is justified. In this case, the covenant was related to a promotion rather than initial employment, and there is no evidence of bad faith or coercion from BDO. Therefore, partial enforcement of the covenant is appropriate, and concerns about rewriting the agreement are misplaced.

No additional substantive terms are necessary, and the time and geographical limitations of the covenant are preserved. The scope of the covenant has been narrowed to a specific class of BDO clients. Rejecting partial enforcement based solely on the extent of necessary contract revisions is inconsistent with modern legal standards that allow for severance and partial enforceability of restrictive covenants. 

The defendant does not dispute that he served some BDO clients covered by the restrictive covenant during the contract, leading to the plaintiff's entitlement to partial summary judgment on liability. Remittal is needed to assess damages, focusing on which former clients of BDO served by the defendant fall under the covenant's coverage. 

The measure of damages hinges on the clause in the Manager's Agreement, which mandates that the defendant compensate BDO for losses at an amount equaling 1½ times the fees charged to each lost client over the last year of service. This clause is characterized as a liquidated damages provision, which is valid if the damages from a breach are difficult to ascertain and the pre-fixed amount is a reasonable estimate of probable harm. 

The difficulty in determining actual lost profits justifies the liquidated damages provision. BDO argues that the agreed amount is not grossly disproportionate to the anticipated harm, referencing the managing partner's affidavit that ties the liquidated damages to standard valuation methods for client accounts in professional services. Courts have upheld similar liquidated damages formulas based on client gross billings as a reasonable measure in accounting practice acquisitions. However, the rationale provided does not definitively eliminate concerns regarding potential gross disproportionality.

The affidavit cited by BDO is the sole evidence supporting the reasonableness of the liquidated damages clause in question. Other courts have previously remitted cases involving similar liquidated damages provisions in accountant employee anti-competitive agreements due to insufficient records proving that the agreed amount was not excessively punitive compared to actual damages. The current case also reflects a lack of substantial evidence, prompting the decision to remit for additional record development regarding the liquidated damages formula. The Appellate Division's order is modified by denying the defendant's motion for summary judgment, granting the plaintiff's motion for partial summary judgment to declare the restrictive covenant enforceable, and remitting to the Supreme Court for further proceedings. Additionally, it is noted that law firm partnership agreements are treated differently regarding restraints on competition, as the relevant public policy does not apply to accountants. Thus, the precedents set in Cohen and Denburg do not necessitate invalidating the restrictive covenant in this case. A different outcome could occur if BDO provided evidence that the defendant had improperly used confidential information to attract clients.