This article is reprinted with permission from the
March 17, 1998 edition of
New York Law Journal.
1998 NLP IP Company.

 


The Duty Not to Compete: A Recent Case

By Joseph E. Bachelder

 

A NEW YORK court recently considered the duty owed by a senior level executive to his employer in connection with a move to a new employer. The executive was employed under a written agreement. The court granted a preliminary injunction against his going to work for the new employer until the end of the employment term with his current employer. 1 MTV Networks v. Fox Kids Worldwide Inc., New York Law Journal, Feb. 6, 1998, at 26 (Col. 4) (N.Y. Sup. Ct., Feb. 5, 1998).

In this case, the executive, Richard Cronin, was serving MTV Networks, a division of Viacom International Inc., as president of TV Land, a cable network specializing in "classic television." He also supervised Nick-at-Nite, a sister network specializing in "classic" situation comedies. He was employed under a contract with an employment term from July 1, 1995, through June 30, 1998.

As president of TV Land, Cronin was involved in developing strategies for TV Land, including how to deal with existing and potential competition. According to the testimony he also "had detailed knowledge of MTVN's budget process" and shared all of its "operating information and plans."

No-Compete Clause

The court sets out certain provisions of Mr. Cronin's contract. These include:

1. the agreement to "devote your entire business time, attention and energies to the business of MTVN and its subsidiaries."

2. the agreement (as part of a no-compete clause) "that your employment hereunder is on an exclusive basis, and that [during a period that, at the time the litigation commenced, would end June 30, 1998] . . . you will not engage in any other business activity which is in conflict with your duties and obligations hereunder." [Material in brackets added.] (The no-compete clause also includes customary language regarding not becoming an officer, employee etc. "for any business directly competitive with that of MTVN" and also to not "make any investments in any company or business competing with MTVN" [with an exception for becoming a shareholder of less than 1 percent "of any company listed on a national securities exchange or quoted on an automated quotation system"]).

In the latter part of August 1997, Haim Saban, chairman and chief executive officer of Fox Kids, a potential, if not yet actual, competitor of MTV Networks, approached Cronin about joining Fox Kids as president of Fox Family, Fox Kids broadcast network and the Fox Kids Cable network.

Cronin responded that he was under contract with MTV Networks until June 30, 1998, and could consider an offer only if it did not require his going to work before July l, 1998. Saban found that to be acceptable and the parties proceeded with the negotiation of an employment agreement.

Before signing the agreement Cronin notified two MTV Networks executives of the Fox offer and they tried to dissuade him. They proposed to increase his compensation at MTV Networks.

When it became apparent that they would not succeed in dissuading him, MTV Networks sent Cronin a letter, dated Oct. 13, 1997, notifying him that "you are not permitted, either under your employment agreement . . . or pursuant to your fiduciary obligations as President, Nick-at-Nite's TV Land, to enter into any other employment agreements, arrangements or understandings with any competitor of MTVN, prior to the expiration of your employment agreement on June 30, 1998."

Cronin signed the employment agreement with Fox, with employment to commence July 1, 1998. Upon learning that he had signed the employment agreement with Fox, MTV Networks notified Cronin it was terminating him for cause. Cronin notified MTV Networks, following such notice, that he was terminating for Good Reason.

Following this preliminary skirmishing, MTV Networks brought an action to enjoin Cronin from going to work for Fox before July 1, 1998. As noted, the term of employment under the employment agreement with Cronin was scheduled to expire June 30, 1998.

Among the causes of action MTV Networks included in its complaint were breach of contract and breach of fiduciary duty by Cronin and tortious interference with contract and aiding and abetting breach of fiduciary duty against Fox Kids.

Planning for Future

The interesting feature of this case is not the "end" issue -- whether MTV Networks could prevent Cronin from competing during the remainder of the term -- but the antecedent issue of whether Cronin breached a duty, or duties, to his employer by entering into an employment agreement with a competitor to take effect after the end of his current term of employment.

Because MTV Networks terminated Cronin for cause and Cronin responded that MTV Networks did not properly terminate him for cause, the Court had to address the issue of whether, during the term of his employment and before terminating to go to work for a competitor, Cronin had breached a duty, or duties, owing to his employer. If he had, his contract gave MTV Networks grounds to terminate him for cause and during the remaining term of employment (that is, until June 30, 1998) to require him not go to work for a competitor.

On the other hand, if MTV Networks terminated him without cause (or if Cronin had grounds for terminating on his initiative for good reason), the MTV Networks contract did not prevent Cronin from competing after his employment with MTV Networks ended even though the period preceded July 1, 1998.

Cronin and Fox argued "there is nothing in his contract which prevented him from planning for his future after the expiration of his contract." The court found that "although it is true that the contract does not expressly state that Cronin may not enter into an employment agreement with another company during the term of his employment, the contract states that he must not engage in any other business activity during its term which is in conflict with his duties and obligations under his contract."

After signing the contract with Fox, as stated in the opinion, "even [Cronin] acknowledges that certain sensitive issues would have been difficult, if not impossible, for him to be involved in. The most obvious of those involves strategy relating to competition with Fox Kids and the Family Channel.

Accordingly, by Cronin's own admission, there were areas of his MTVN job in which he would no longer be able to function effectively." The court further notes "As Rosenberg and Scannell [MTV Networks executives] convincingly testified, once Cronin entered into his employment agreement with Fox Kids, he could no longer be trusted to perform his duties at MTVN or act as a credible spokesman for TV Land or Nick-at-Nite." 2

In deciding that Cronin should be enjoined from going to work for Fox Kids before July 1, 1998, the court does not consider separately (from the contract issue) whether Cronin, as president of TV Land, owed a fiduciary duty to MTV Networks not to enter the contract with Fox Kids. Therefore, the implications of the MTV Networks case should be limited to circumstances involving contract provisions such as those in Cronin's contract. It is interesting to speculate what a New York court might conclude absent a contract and based only on a fiduciary duty owing by an officer to his employer. 3 Speculation on what such conclusion might be is beyond the scope of this column.

Contract Issues

As applied to the substantial activity today of executives moving from one employer to another employer the MTV Networks case is one worth paying careful attention to. It suggests important issues arising from the negotiation of contracts with executives who are moving from Company A to Company B.

1. Does an executive, under a contract like Cronin's, have a duty not to even enter into negotiations to become employed by Company B while still employed by Company A?

If, for example, an executive is actively negotiating a contract with Company B and, at the same time, attending budgetary and strategic planning meetings at his current employer, is there such a conflict of interest that the executive is breaching a duty he owes to Company A (again, assuming contract provisions like Cronin's)? If Company B is a competitor, under the rationale of the MTV Networks case there could be a breach of such a duty.

What if Company B is not a competitor? What if the negotiations with Company B have reached a point -- such as signing a letter of intent -- that the executive is virtually certain that he will be leaving Company A? The executive may be involved in the making of strategic decisions that are being made on the assumption by his employer that he will be there to implement those decisions. Without him to carry them out, Company A might not be prepared to make those decisions. Thus the problem could exist without reference to whether Company B is a competitor.

2. Assume the answer to question 1 above is a conditional one: Yes, there is a duty, depending on the circumstances. Is there a point to which negotiations with Company B must proceed before there is a breach of the duty (again, under contract provisions like Cronin's) owed by the executive to his current employer, Company A? Could any or all of the following steps in the negotiation process be found, in particular circumstances, to amount to a breach of a duty owed by the executive to Company A?

(a) The executive's engaging in discussion of a job opportunity with Company B by telephone from the executive's office during business hours (i) with a search firm or (ii) directly with Company B?

(b) The executive's discussion of a job opportunity with Company B in repeated visits with (i) the search firm and/or (ii) executives of Company B?

(c) The executive's meeting with members of the search committee of the board of directors of Company B? Attending a dinner meeting with all the members of the board of directors of Company B?

(d) The executive's initialing a letter of intent that is subject to further negotiations to convert it into a formal employment agreement?

(e) The executive's signing an employment agreement that is not to become effective until the executive (i) meets with the CEO of Company A and (ii) thereafter advises Company B that the employment agreement can take effect?

Among the variables relevant to answering these questions are (i) is Company B a competitor, (ii) are the contract provisions similar to Cronin's and (iii) what is the executive's position at Company A and how important (including how unique) is he to Company A's business? As already noted, this column does not address a further, interesting issue: Absent any contract, are there one or more circumstances described above that might conflict with a fiduciary duty of an officer (who may also be a director)?

3. What can an employer do to prevent what Mr. Cronin did -- negotiating and then signing an employment agreement during his employment with MTV Networks?

(a) An employer can require a post-employment no-compete period as part of an employment agreement or by separate agreement. Enforceability will depend upon length of time and geographic scope as well as a showing that absence of enforcement would cause harm to the employer to an extent that justifies the restriction upon the freedom of the executive to go to work where he or she chooses. 4

A post-employment no-compete during the three-year period of the employment agreement -- ending June 30, 1998 -- is, of course, what MTV Networks required of Cronin (unless it terminated him without "cause" or he terminated for "good reason" in which event there was no post-termination no-compete agreement).

MTV Networks could have required that Cronin not go to work for a competitor for a period -- day, six or 12 months -- following June 30, 1998, or following any termination of employment, if sooner. It did not, however, so contract. For this reason the issue arose, as discussed, over whether Cronin was terminated by MTV Networks "for cause" (in which event the post-termination no-compete did apply until June 30, 1998).

(b) Even without a no-compete clause, an employer might require that an executive (i) not accept an offer from a competitor without first advising the employer of the offer, (ii) give the employer, say, six months to make a counter-offer and (iii) enter into good faith negotiations regarding such counter-offer. Since no-compete clauses have been sustained by courts for periods of longer than six months, such a clause, if otherwise reasonable (e.g., in geographic scope), should be sustainable under New York law. An interesting question would be whether requirements such as those noted in clauses (i) to (iii) of the first sentence of this paragraph (b) might be extended to include prospective employers that are not competitors.

(c) Could an employer go one step further than suggested by clauses (i) to (iii) in paragraph (b) and require that an executive (i) not even discuss a specific job offer with a competitor without notifying the employer, (ii) give the current employer opportunity to make a counter-offer and (iii) enter into good faith negotiations regarding such counter-offer? The rationale of the MTV Networks case, if extended a bit, would seem to support the enforceability of such an agreement.

In the MTV Networks case, the court cited evidence that once the employment agreement with Fox had been signed by Cronin, MTV Networks could no longer trust him to carry out his duties with MTV Networks. Carrying this reasoning one step further, can an executive who has received a specific job offer from a competitor and is in the process of negotiating -- without notifying his employer -- be trusted to carry out his current job without ambivalent loyalties?

The likely effect of a provision such as that described in clauses (i) to (iii) above of this paragraph (c) would be a significant deterrent on negotiations by executives and prospective employers even if its enforceability might be subject to debate.

In those jurisdictions that permit blue penciling, as does New York, a no-compete clause's enforceability can be reinforced by providing that to the extent a court finds the clause to be too broad the parties intend that it be limited to whatever extent is necessary to make it enforceable. Likewise, clauses like those noted above might contain a "blue pencil" provision limiting the requirement of disclosure to the employer of a specific job offer to those circumstances that a court would find reasonable -- e.g., negotiations with a competitor within an appropriate geographic area.


FOOTNOTES:

1 The plaintiff, in its complaint, also seeks damages and the imposition of a constructive trust against the prospective employer. The Feb. 6, 1998, decision does not address the issue of damages or the imposition of a constructive trust.

2 An interesting case also involving the entertainment industry is American Broadcasting Cos. v. Wolf, 420 NE2d 363 (N.Y. 1981). In that case the Court of Appeals affirmed a decision that injunctive relief was not an appropriate remedy. The court did conclude that Wolf breached a provision in the employment contract (not present in Cronin's contract) requiring him to "enter into good faith negotiations" with ABC for 90 days. The court's decision not to grant injunctive relief expressly did not foreclose ABC's right to pursue monetary damages.

3 According to one treatise, "an officer or director is generally free to make arrangements or preparations to go into a competitive business before terminating his relationship with the corporation, provided no unfair or wrongful acts are committed in the course of such preparations." Brodsky & Adamski, Corp. Officers & Directors, 4:14. Clark Boardman Callaghan (1997).

4 New York courts frequently address public policy concerns about restrictive covenants that inhibit competition and interfere with an " . . . employee's right to apply to his own best advantage the skills and knowledge acquired by the overall experience of his previous employment." The courts weigh these concerns against the "legitimate interest an employer has in safeguarding that which has made his business successful and to protect himself against deliberate surreptitious commercial piracy." Reed, Roberts Assocs. Inc. v. Strauman, 40 NE2d 303, 307, (N.Y. 1976). See generally Sara C. Kinsey, Note, "Enforceability on Non-Competition Provisions in Executive Employment Agreements: A Fresh Look at New York Law," 36, N.Y.L. Sch. L.Rev. 445, 445-454 (1991) (discussing public policy concerns of non-competition covenants).